Community and Economic Development Loans: Securitization Faces	 
Significant Barriers (17-OCT-03, GAO-04-21).			 
                                                                 
Community economic development (CED) lenders serve the credit	 
needs of nonconventional borrowers and economically distressed	 
areas across the nation. However, little is known about this	 
industry, its ability to tap private sources of capital, and loan
performance and volume in the industry. To provide information	 
that would be helpful in considering the role that the federal	 
government might play in facilitating the creation of a secondary
market for CED loans, GAO was asked among other items to (1)	 
determine the barriers to more widely securitizing CED loans and 
(2) identify options for overcoming these barriers and the likely
implications of these options.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-21						        
    ACCNO:   A08736						        
  TITLE:     Community and Economic Development Loans: Securitization 
Faces Significant Barriers					 
     DATE:   10/17/2003 
  SUBJECT:   Economic development				 
	     Federal funds					 
	     Funds management					 
	     Lending institutions				 
	     Community development				 
	     Economically depressed areas			 
	     Strategic planning 				 

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GAO-04-21

United States General Accounting Office

GAO

                       Report to Congressional Requesters

October 2003

COMMUNITY AND ECONOMIC DEVELOPMENT LOANS

                              Securitization Faces
                              Significant Barriers

                                       a

GAO-04-21

Highlights of GAO-04-21, a report to congressional requesters

Community economic development (CED) lenders serve the credit needs of
nonconventional borrowers and economically distressed areas across the
nation. However, little is known about this industry, its ability to tap
private sources of capital, and loan performance and volume in the
industry. To provide information that would be helpful in considering the
role that the federal government might play in facilitating the creation
of a secondary market for CED loans, GAO was asked among other items to
(1) determine the barriers to more widely securitizing CED loans and (2)
identify options for overcoming these barriers and the likely implications
of these options.

October 2003

COMMUNITY AND ECONOMIC DEVELOPMENT LOANS

Securitization Faces Significant Barriers

CED lenders rely on multiple federal programs that offer grants, loans,
guarantees, and other support to help fund lending activities. Some of
these lenders have expressed an interest in finding alternative sources of
funding, including securitizing the loans that they make. However, the
volume of CED loans potentially available for securitization is not known.
In addition, the community economic development industry is characterized
by nonstandard underwriting, loan documentation and loan performance
information, and limited mechanisms for securitizing loans. Without
greater understanding of available loan volume, the capital markets have
little interest in developing standards or mechanisms for securitizing CED
loans.

CED lenders also face barriers to securitizing their loans. Some of these
barriers are unique to CED lending, including: limited lender capacity to
manage a securitized portfolio of loans; the external legal and regulatory
limitations and requirements governing the use of the funds that these
lenders receive; and the high cost of originating and servicing CED loans.

This report describes options that the federal government might exercise
to address the identified barriers. This report also describes the
implications that implementing each option might have, including the
potential for increased federal costs and changes in lenders' missions.
Ultimately, securitization may not be a significant alternative for CED
lenders until the volume of loans available for securitization is better
known and lenders are convinced of the benefits of participating.

Wall Street and Main Street Face Barriers to Securitizing Economic
Development Loans

www.gao.gov/cgi-bin/getrpt?GAO-04-21.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact William Shear at (202)
512-4325 or [email protected].

Contents

  Letter

Results in Brief
Background
CED Lenders Share Similar Missions, but Markets Targeted and

Loan Information Vary As with the Lenders They Serve, Federal Programs
Share Similar Missions, but Differ in How They Operate Selected
Securitization Models for Small Business and CED Loans

Have Similarities and Differences We Identified Barriers to Securitizing
CED Loans Potential Options Exist to Overcome Barriers, but Most Imply
Costs

or Changes to Federal Programs Observations Agency Comments and Our
Evaluation

1 2 6

9

16

26 35

43 54 56

Appendixes                                                              
               Appendix I:       Objectives, Scope, and Methodology        59 
                           CED Lender Characteristics and the Performance  59 
                                           of Their Loans                  
                                    Selected Federal CED Programs          60 
                            Selected Securitization Efforts for CED Loans  62 
                                 Barriers to CED Loan Securitization       63 
                                Options for Securitization and Their       63 
                                            Implications                   
              Appendix II:               Model Descriptions                65 

Tables	Table 1: Table 2:

Table 3: Table 4:

Table 5:

Table 6:

Table 7: Table 8:

Table 9:

Sources of Lender Funding 12
FederalPrograms andType of Assistance Provided to CED
Lenders 18
Summary of Programs and Their Target Market Criteria 21
Appropriations for CED Lending Have Declined in
Selected Federal Programs (Fiscal Years 1998-2003) 22
Number of Lenders and Dollar Volume of Federal Support
(Fiscal Years 1998-2002) 23

Securitization Models and Lenders and Borrowers

Involved 27
Types of Loans Pooled Varies by Model 28
Credit Enhancements Used to Distribute Credit Risks Vary

by Model 32
Federal CED Lending Programs, Lender Types, and
Sponsoring Agencies Included in Our Review 61

Contents

           Figure 1: Figure        Role of Participants in a Common           
Figures               2:   Securitization Model Business and CED Loan    7
                                         Performance Measures              
                                   Collected about Each Lender Type        14 
                  Figure 3:  Levels of Outstanding Securitized Loans Have  
                                                 Not                       
                             Reached the Levels of More Well-Established      
                                                Models                     34

Abbreviations

ARC Appalachian Regional Commission
BRV bankruptcy-remote vehicle
CED Community and Economic Development
CDA Commonwealth Development Associates
CDBG Community Development Block Grant
CDC Community Development Corporation
CDFI Community Development Financial Institution
Commerce U.S. Department of Commerce
CRF Community Reinvestment Fund
CSBG Community Services Block Grant
EC/EZ Enterprise Community/Empowerment Zone grant
EDA Economic Development Administration
EDI Economic Development Initiative
HUD U. S. Department of Housing and Urban Development
HHS U. S. Department of Health and Human Services
IRP Intermediary Relender or Intermediary Relending Program
RBEG Rural Business Enterprise Grant
RLF Revolving Loan Fund
SBA U.S. Small Business Administration
SEC U.S. Securities and Exchange Commission
Treasury U.S. Department of the Treasury
USDA U.S. Department of Agriculture
504 CDC Section 504 Certified Development Companies

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separately.

A

United States General Accounting Office Washington, D.C. 20548

October 17, 2003

Congressional Requesters:

Community and economic development (CED) lenders make loans to qualified
businesses that are generally unable to obtain suitable financing from
conventional private-sector lenders. CED lenders rely on a variety of
funding sources including the federal government, but tend not to rely on
securitization as a funding source.1 If properly structured,
securitization represents an option that could offer lenders increased
liquidity for additional lending and offer borrowers greater availability
of loanable funds.2 Some of the federal programs that support CED lending
have considered using securitization to provide lenders greater access to
capital.

This report responds to your July 11, 2002, request for information on CED
lending. Based on the potential benefits that securitization may offer
lenders and borrowers, you asked us to describe the characteristics of (1)
selected federally sponsored CED lenders, (2) the federal programs that
sponsor them, and (3) selected existing and proposed models for
securitizing CED loans. You also asked that we (4) determine the barriers
to more widely securitizing CED loans, and (5) identify options for
overcoming these barriers and the implications of these options.

To address the first two objectives, we reviewed studies and other
documents obtained from lender trade associations, program regulations,
procedures, and guidance and spoke with program and industry officials
representing seven federally sponsored CED lenders we were requested to
review and the federal programs that support them.3 To describe efforts to
securitize CED loans, we reviewed agency and trade association documents
and spoke with representatives of organizations undertaking securitization
efforts. To determine the barriers to securitizing CED loans

1Broadly, securitization is a process whereby lenders and others create
pools of loans and sell to investors securities that are backed by cash
flows from these loan pools-thereby replenishing funds available for
lending.

2Lender liquidity is a measure of a lender's ability to meet its current
financial obligations. It implies that the quality of the lender's assets
are such that they can be readily converted into cash with minimal loss in
market value.

3Our review does not include lenders identified as Community Development
Enterprises financed through the Department of Treasury's New Markets Tax
Credit because these entities were only recently established.

and potential options for overcoming them, we synthesized information from
our literature search, as well as information gathered from interviews
with program officials, CED lender representatives, capital market
participants, researchers, and others knowledgeable about CED lending and
securitization. Finally, we developed additional options the federal
government might exercise for potentially overcoming identified barriers
and explored the implications of these options, as well as those proposed
by others. The options for overcoming the barriers often entail additional
federal costs and, given the scope of this review, we were unable to
determine whether the benefits would exceed the costs that could result
from such efforts. Therefore, we do not endorse these options. Also, our
work focused on access to capital through securitization, not through
other means. We conducted our work in Washington, D.C.; Philadelphia,
Pennsylvania; and Manchester, New Hampshire, between October 2002 and July
2003 in accordance with generally accepted government auditing standards.

Results in Brief	While the seven groups of CED lenders we reviewed have
similar missions, available data show variation in the types of borrowers
they serve, the investments they make, and how they are capitalized.4
However, little is known about the industry as a whole. CED lenders vary
in the types of loans they make. For example, some lenders tend to focus
on operating loans, while others may focus on real estate loans. Lenders
are funded by federal, as well as state, local, private, and philanthropic
funding sources. Federal funding sources, however, are important for all
of the lenders included in our review because they provide lenders engaged
in high-risk lending with low-cost funding. Data on the amounts the
lenders invest in communities were not current or complete for lenders in
our review. In addition, because data on lender activity are reported
through multiple channels, data on the total number of lenders and the
amount they invest- as a group-in communities are not available. Loan
performance data were not available or current on all lenders. Finally,
because of the various

4The seven groups of lenders reviewed are (1) Community Development
Financial Institutions (CDFIs); (2) Revolving Loan Funds (RLFs); (3)
Intermediary Relenders funded by the Department of Agriculture's (USDA's)
Intermediary Relending Program (IRPs); (4) Community Development
Corporations (CDCs); (5) Small Business Administration (SBA) 504 Certified
Development Companies (504 CDCs); (6) microlenders; and (7) lenders
supported by Community Development Block Grant (CDBG) entitlement and
state grantees.

sources of data on CED lenders, loan performance is not consistently
defined. Therefore, it is difficult to describe the performance of CED
loans.

The federal programs that support CED lenders have similar missions-to
improve economic conditions in communities considered to be distressed or
underserved. However, the type of federal support they provide and the
targeted lending criteria they use differ. These programs also differ in
terms of the number and type of lenders they support and awards made. In
fiscal years 1998-2002 these federal programs provided billions to support
CED lending in the form of grants, loans, loan guarantees, and equity
investments. However, federal funding for some of these programs has
declined in recent years. Some programs use securitization, or have
considered using securitization, to help lenders in accessing capital
markets to maintain or expand lending activity. Finally, these programs
collect and maintain data to oversee lender's activities using various
methods and have different reporting requirements.

The five existing and three proposed securitization models that we
reviewed illustrate a variety of structures to securitize small business
and CED loans and vary in the amount of CED loans that they securitize.5
Each of the existing and proposed models varies in terms of the types of
loans pooled and the method for pooling the loans. All of the models we
reviewed utilize or propose differing forms of credit enhancements, funded
by the federal government, participating lenders, or others to limit
credit risk to investors.6 Accordingly, each of the models distributes the
risks and benefits associated with securitization differently among
participants- borrowers, lenders, poolers, investors, and government(s).
The structure of these models can affect participants' willingness to
engage in securitization and cost incurred by the federal government.

5The five existing models include those for securitizing SBA 504 program
loans, unguaranteed SBA 7(a) loans, guaranteed SBA 7(a) loans, and HUD
Section 108 guaranteed loans, and the securitization model used by the
Community Reinvestment Fund-a nonprofit secondary market maker for
CED-based lenders nationwide. We also reviewed three models proposed by
various sources-Commonwealth Development Associates' (CDA) model proposed
under the EDA 2001 securitization demonstration, HUD's proposed CDBG
/Section 108 model, and Capital Access Group's proposed Capital Access
Program securitization model.

6A credit enhancement is a payment support feature that covers defaults
and losses up to a specific amount, thereby reducing investor need for
loan-specific information. It acts to increase the likelihood that
investors will receive interest and principal payments in the event that
full payment is not received on the underlying loans.

We identified six key barriers to securitization, all of which keep
lenders from working with capital markets.

o 	First, borrower demand is not known across targeted markets, and CED
lenders generally lack incentives-both market-based and federally
driven-to participate in securitization. As a result, the volume of loans
that could be securitized is not well understood.

o 	Second, many CED lenders lack the capacity to securitize their loans.
For instance, their reliance on small, less-diversified portfolios that
require intensive servicing results in higher per loan costs. Also many
lenders do not have financial information-such as their cost to originate
and service these loans and the expected income from these loans-that is
needed to assess whether securitizationis a viable option. Nor can they
readily obtain the staffing resources or skills needed to expand lending
activity that might be required when securitizing their loans.

o 	Third, external requirements-statutory or programmatic-attached to
funding sources may directly or indirectly inhibit the securitization of
loans.

o 	Fourth, CED lenders believe that selling their below-market-rate loans
would require them to absorb too high a discount to benefit from a
securitization.

o 	Fifth, lack of lender standardization and performance information
impedes securitization by increasing the cost of securitizing these loans.

o 	Finally, mechanisms available to support securitization for CED loans,
such as information links between capital markets and lenders and loan
pool assemblers, are limited in number and capacity.

We identified a range of options the federal government could use to
address each of the barriers to securitization. Undertaking any of these
options could have important implications in terms of cost to the federal
government, mission of CED lenders, and lender and program management. For
instance, to address lack of lender participation, incentives could be
built into existing federal programs for lenders who are willing and
capable of securitizing their loans. However, such incentives might
require federal funds, and the extent to which this might result in
sufficient loan volume to make securitization viable is not clear. To

improve lender capacity, the government could allow for set-asides within
existing programs for training and technical assistance to lenders
designed to help lenders improve portfolio management, staff skills, and
their financial information. This option, however, might reduce the funds
available to support lending. The government could also remove program
restrictions that inhibit or prohibit securitization such as restrictions
on the use of loan repayments, which could affect lender missions. To
improve standardization and performance information, the government could
provide incentives for lenders and capital market participants to develop
a useful level of standardization and performance information tailored to
CED loans-which could lower the cost of underwriting loans, but could also
result in lenders moving away from target markets. Such incentives could
include funding set-asides, changes in program award selection criteria,
or even increased program funding to those lenders-all of which may entail
added program costs that should be assessed. Improved information on
lending activity and loan performance could also help managers make better
program decisions. To overcome the limited mechanisms to securitize CED
loans, the federal government could provide a variety of different credit
enhancements that would improve the investment quality of these securities
and minimize standardization requirements for lenders, but which might
also have a negative financial impact on the federal budget.

While we do describe the likely implications of many of the options we
identified, we did not measure the extent to which each may affect
lenders' mission, federal costs, program oversight, and other potential
implications. Likewise, we did not determine whether the benefits would
exceed the costs that could result from such efforts. We, therefore, did
not endorse these options, and this report contains no recommendations.
The information we present provides a framework for understanding the
challenges, benefits, and costs of securitization. Based on our findings
and this framework, the final section in this letter presents some
observations on the nature of barriers CED lenders face in securitizing
loans.

We provided a draft of this report to the U.S. Department of Agriculture
(USDA); U.S. Department of Commerce (Commerce); U.S. Department of Housing
and Urban Development (HUD); U.S. Department of Treasury (Treasury); U.S.
Small Business Administration (SBA); U.S. Department of Health and Human
Services (HHS); and the Appalachian Regional Commission (ARC). Officials
in all agencies provided technical comments that we incorporated into the
report, where appropriate. The technical comments from HHS were from
officials in HHS's Administration for

Children and Families. Generally the agencies did not indicate whether
they agreed or disagreed with the report's findings.

Background	The federal government funds CED lending through a variety of
mechanisms, including grants, loans, loan guarantees, and tax
expenditures. Many government officials, academics, CED lenders, and
nonprofits have recognized the value of identifying ways to maximize the
impact of CED dollars. These efforts have resulted in alternative
mechanisms CED lenders can use to access private, rather than
governmental, funding for CED purposes. For example, CED lenders have
worked with local banks by providing subordinate financing.7 Lenders have
also received equity-like investments from banks. In addition, lenders
have sold CED loans to replenish loan funds. Many have studied
securitization of CED loans as a potential option to access additional
private capital.

Securitization is a process that packages relatively illiquid individual
financial assets, such as loans, leases, or receivables with common
features, and converts them into interest-bearing, asset-backed securities
with characteristics marketable to capital market investors.8 As outlined
in figure 1, the participants in securitization-borrowers, originating
lenders, pool assemblers, credit raters, investors, and sometimes
third-party credit enhancers-each assume specific roles during the
transaction. Additionally, each of these participants derives specific
benefits from the transaction. For example, borrowers gain access to
loanable funds with favorable terms-such as longer payment terms and fixed
rates-that may otherwise be unavailable. Securitization offers originating
lenders a tool to improve their risk and balance sheet management, as well
as potential new fee or income streams and the ability to put existing
capital to other purposes. Securitization also allows the cash flows from
pools of assets to be structured to match the appetites of investors;
thus, investors can diversify with access to new securities that satisfy
their maturity, risk, and return preferences.

7In the case of a loan default, providers of subordinate financing have a
claim to borrower assets that is junior, or secondary, to the claims of
the provider of the senior financing.

8Anand K. Bhattacharya and Frank J. Fabozzi, ed., Asset-Backed Securities,
(New Hope, Pennsylvania: Frank J. Fabozzi Associates, 1996).

Figure 1: Role of Participants in a Common Securitization Model

Credit  Pool        Third-party 
raters  assemblers  credit      
                       enhancer    

Source: GAO.

aAlso known as a special purpose vehicle, a bankruptcy-remote vehicle is
established to legally purchase the financial assets for the purposes of
removing the assets from the credit risk associated with asset originators
or the pool assembler.

The degree to which participants receive these benefits depends largely on
how well, or efficiently, the markets for securitized assets are
functioning. With better current and historical performance data on
financial assets, capital markets can more easily profile the risk of a
pool of similar assets. This risk can be divided and sold to investors who
are willing to purchase it at an acceptable risk-adjusted return
(investor-required yield). As the markets for particular securitized
assets grow more voluminous and liquid, and the performance of securitized
assets as well as the risks associated with securitization become better
understood, investor-required yields on particular asset-backed securities
can decline. Additionally, the

transaction costs of securitizing assets can also decline as the assets
become better understood. Declining investor-required yields and
transaction costs can lower the cost of financing for originating lenders
and ultimately borrowers. Conversely, with inadequate performance data,
and low volumes of similar financial assets, these benefits may not
sufficiently materialize for securitization to be a viable financing
arrangement for originating lenders and borrowers.

Home mortgages are the most well-established securitization market in the
United States. Private conduits, such as commercial banks, and
governmentally sponsored conduits such as the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac), have combined to securitize trillions of dollars of home
mortgages over the past three decades. According to the Federal Reserve,
as of the end of 2002, there were over $3 trillion dollars of securitized
home mortgages outstanding. With visible and voluminous demand for home
mortgage financings evident in the late 1960s and early 1970s, Congress
restructured Fannie Mae and created Freddie Mac and the Government
National Mortgage Association (Ginnie Mae) to provide secondary market
outlets for home mortgage lenders using private capital.9 Ginnie Mae
pioneered the securitization of the Federal Housing Administration and the
Veteran's Administration home mortgages-which already had standard
underwriting and documentation guidelines, robust secondary markets, and
benefited from federal guarantees-in 1970. Freddie Mac, and later Fannie
Mae, did the same for nonfederally guaranteed mortgages, developing
uniform guidelines for mortgage underwriting and documentation, and
educating a diverse set of mortgage lenders nationwide about the benefits
of securitization.

In addition to home mortgages, financial assets such as commercial
mortgages, consumer credit receivables, and even small business and CED
loans have been securitized.10 Today, outstanding securitized commercial
mortgage and consumer credit receivable volume ranges in the hundreds of

9Congress established and chartered Fannie Mae and Freddie Mac as
government-sponsored, privately owned and operated corporations to enhance
the availability of mortgage credit across the nation during both good and
bad economic times. Congress established Ginnie Mae as a government-owned
corporation within HUD responsible for activities including guaranteeing
mortgage-backed securities backed primarily by cash flows from Federal
Housing Administration and Department of Veterans Affairs mortgages.

10Consumer credit receivables include assets such as auto loans and credit
card receivables.

billions of dollars. However, despite favorable regulatory treatment,
lending institutions have securitized less than $6.2 billion of
nonfederally guaranteed small business loans from 1994 through 2001. 11
During this same time frame, lending institutions securitized
approximately $22 billion of SBA-guaranteed small business loans.12 As a
rough point of comparison, in June 2001 commercial banks held an estimated
$450 billion in outstanding small business loans.13 In a previous report,
we attributed the lack of securitized small business loans to the wide
variety of small business loan products, difficulty communicating the
performance of small business loans sufficiently and cost-effectively to
capital markets, and sporadic visible financial benefits for originating
lenders and investors to securitize these loans.14

  CED Lenders Share Similar Missions, but Markets Targeted and Loan Information
  Vary

The seven types of federally sponsored CED lenders reviewed have similar
missions: to service the credit needs of small businesses and others that
generally cannot access funding otherwise or are located in communities
that are considered underserved. However, these lenders differ in the
types of borrowers they serve, the types of loans they make, and their
sources of funding. Also, the total number of lenders and the amount they
invest in communities are not known. Finally, the performance of CED loans
is difficult to describe because consistent performance data are not
available for all lenders in our review.

11Congress passed the Riegle Community Development and Regulatory
Improvement Act (Riegle Act) in 1994 to remove several legal and
regulatory impediments to small business and commercial mortgage
securitizations, including favorable regulatory capital treatment for
depository institutions, and preemption of state securities registration
and investment restrictions. This data is from the Federal Reserve Board
and includes pools of nonguaranteed portions of SBA 7(a) loans and pools
of other non-federally guaranteed loans.

12Federal Reserve Board. Includes pools of guaranteed portions of SBA 7(a)
loans.

13Federal Reserve Board. The board notes that their 1998 Survey of Small
Business Finance indicates that commercial bank small business loans
outstanding represents roughly 65 percent of all small business lending.

14U.S. General Accounting Office, Small Business Administration: Size of
the SBA 7(a) Secondary Markets Is Driven by Benefits Provided,
GAO/GGD-99-64 (Washington, D.C.: May 26, 1999).

Lenders Have Similar Missions in Financing Underserved Markets

All of the lenders we reviewed have similar missions to service CED credit
needs in low- and moderate-income communities or borrowers that are
considered to be underserved. Borrowers served by CED lenders are
perceived by traditional sectors as high risks-that is, they have
difficulty accessing credit either because they have poor or nonexistent
credit histories, insufficient collateral, or are start-up businesses with
no track record. Some lenders also help borrowers gain access to capital
from conventional sources (for example, banks) by providing a portion of
what the business needs and agreeing to let the bank recoup its losses
first from the business' collateral in the event of default.

CED lenders employ several strategies to meet their missions. For
instance, they work extensively with their borrowers and target loans
rejected by banks. According to lenders with whom we talked and studies we
reviewed, lenders must work extensively with their borrowers, providing
loan servicing and technical assistance to help borrowers make consistent
loan payments and sound business decisions to ensure their survival. In
addition, lenders also devote more time to their borrowers than that
required for conventional loans to help borrowers qualify for CED loans.

Lenders Target a Range of Borrowers and Products and Receive Funding from
Various Sources

While overall missions of CED lenders we reviewed are similar, they differ
somewhat in terms of the types of borrowers they serve, products they
offer, and the targeted location of their investments. The lenders may
support a range of borrowers, from poverty-level to moderate-income. Many
of the lenders focus on start-up businesses. Some lenders have more
specific targets. For example, microlenders serve businesses with five or
fewer employees and capital of $25,000 or less. Lenders may offer loans
for working capital, equipment, or real estate; however, some concentrate
more on one type of loan than others. For example, 504 Certified
Development Companies focus on commercial real estate and equipment loans,
while microlenders concentrate on working capital and equipment loans.
Some lenders service specific geographic areas. For instance, ARC Business
Development Revolving Loan Fund lenders service borrowers in the
Appalachian region.

As shown in table 1, lenders receive funding from various sources
including federal, state, local, private, and philanthropic sources of
capital as well as earned income. According to lenders, trade association
representatives and studies we reviewed, federal funding sources are
important because

they provide low-cost capital for high-risk loans they finance. In
addition, federal funding makes up a significant portion of the capital
available to some lenders. We also found that the source of federal
funding for these lenders varies. For instance, federal funding for CDFIs
comes from the U.S. Department of Treasury. In addition, some
CDFIs-particularly those that finance microloans, and that are also
classified as CDCs-also receive funding from HUD, SBA, Commerce, USDA, and
HHS.

Finally, lenders generate income from interest earned and administrative
fees they charge borrowers for services and loans. According to lenders
and other research, lenders rely on these earned-income sources to cover
their operating costs. Earned income also is important to many lenders
because other funding sources do not allow lenders to use a portion of the
funding to cover operating costs.

Table 1: Sources of Lender Funding

             Nonfederal sources Federal sources State Local Private

Earned Income Othera Treasury Commerce HUD USDA SBA HHS ARC

             Community Development                                          
            Financial Institutions           X  X  X  X  X  X  X  X  X  X X 
                    (CDFI)                                                  
                 Microlenders                X  X  X  X  X  X           X X 
Community Development Corporations (CDC)  X  X  X     X  X  X  X  X  X X 
      Revolving Loan Fund lenders (RLF)b     X  X  X  X  X     X  X  X  X X X 
         Intermediary Relenders (IRP)        X  X  X  X              X      
                 504 Certified                                              
             Development Companies                 X  X  X              X   
                   (504 CDC)                                                
             Lenders supported by                                           
             HUD's Section 108 and                    X           X         
                CDBG programsc                                              

Sources: Lender trade associations and federal programs.

aOther includes individual investors, philanthropic investors, and
utilities.

bIncludes EDA- and ARC-sponsored RLFs. However, RLFs may receive funding
from multiple federal sources.

cHUD Section 108 and CDBG lenders are local government agencies or
nonprofit intermediaries.

Total Number of CED Loans and Amount of CED Lending Are Not Known

Data on the number and amount of CED loans invested in communities are not
current or complete for all lenders targeted by our review. For example,
data on the number and amount of loans these lenders make are sometimes
only collected for a sample of lenders. Data on the number and amount of
loans for microlenders were collected in September 2000, but cover only
308 of the 554 identified microlenders. Similarly, the most recent
reporting time frame for 504 CDC data is fiscal year 2001 but covers about
272 lenders. Data on the amount and number of CDFI loans covers 389 of the
800-1000 CDFIs identified. The latest survey on Community Development
Corporation lenders was completed in 1997 and indicated that there were an
estimated 3,600 CDCs nationwide-as many as 776

reported making CED loans. 15 Data on loan numbers and amounts for IRPs
cover only 29 out of the 400 IRPs identified by the trade association that
represents them. 16 Data are reported on 422 Department of Commerce RLFs
and 1,012 lenders supported by Section 108 and CDBG programs. However, the
total universe of these lender types is unknown.17

In addition, it is impossible to aggregate available data to determine the
total number of CED lenders and the number or dollar volume of loans they
make because some lenders may be counted in more than one lender group.
For instance, as indicated previously, both microlenders and CDCs may also
be CDFIs. Many lender types can be supported by HUD's Section 108 and CDBG
grant programs. Given the data limitations, the total volume of loans and
dollars invested in communities through CED lending is also unknown.

Loan Performance Data Are Limited, but Attempts Have Been Made to Improve
Data

Loan performance data, including data on loan delinquencies, defaults, and
loss rates were not available, complete or defined consistently for both
ongoing and one-time data collection efforts (see figure 2).18 For
example, loan performance data are not available for CDCs at all. The CDFI
Fund and other ongoing sources of data on CDFIs do not track default rates
at all. Conversely, ongoing data collection on IRPs covers defaults and

15The National Congress for Community Economic Development, a trade
association for Community Development Corporations conducts a survey on
these lenders. The next survey is not scheduled for completion until 2004.

16While data on the number and amount of loans made by IRPs are limited,
USDA, which currently funds 400 IRPs is drafting a new template to be used
by IRPs requiring lenders to provide more detail on their lending
activity.

17Data on the total number of RLFs and HUD-supported lenders are
unavailable. RLFs do not have a central organization that maintains data
on the RLF industry as a whole. While an attempt to collect RLF data was
made by the Corporation for Enterprise Development in 1997, it was not
successful because reliable data were not available at that time on many
of the RLFs. Also, RLFs funded by HUD's CDBG program were excluded from
the count. HUD's recent attempt to identify its grantees using Section 108
and CDBG dollars for CED lending resulted in the identification of 1,012
state and local entitlement grantees. However, because these grantees make
direct loans to businesses and to nonprofit intermediaries (such as RLF
lenders), identified grantees do not represent the universe of the lenders
supported by the programs.

18Delinquency refers to a situation where an entity falls behind agreed
payment dates in making payments. Defaults occur when the lender no longer
believes that the business will make payments. Losses are the monetary
losses to the loan holder in the event of borrower default, less any
monetary value recovered from the liquidation of loan collateral.

delinquencies, but only at an aggregate level-not at a loan level. In
fact, only EDA, SBA, and ARC collect loan-level performance information on
an ongoing basis (for the RLF, 504 CDC, Microlenders, and ARC/RLF
programs).

Figure 2: Business and CED Loan Performance Measures Collected about Each
Lender Type

Legend

Data collected at the loan level
Data collected at the aggregate level
Data are not collected
Sources: Reports maintained by lender trade associations and federal
programs.

aRutgers University, "EDA RLFs-Performance Evaluation," 2002. These data
do not include non-EDA RLFs.

bUrban Institute, "Public-Sector Loans to Private-Sector Businesses: An
Assessment of HUD-Supported Local Economic Development Lending
Activities," 2003.

cWhile the total number of lenders is not known, loans covered by the 51
lenders in the Urban Institute Study account for over 50 percent of
third-party lending for CED loans made, and up to 58 percent and

at least 96 percent respectively, of third-party CED loan dollars tracked
in HUD's CDBG and Section 108 state and local entitlement programs.
Therefore, coverage is fairly high.

dAbt Associates, Inc., "CDFI Fund Secondary Market Survey of CDFIs," 2002.

eAbt surveyed 108 CDFIs but received only 54 responses from the survey on
loan-level performance data. In addition, all measurements were not
reported on all loans. For instance, recovery amounts are available on
fewer than 2 percent of the loans. Measurements for delinquencies reported
30 days past due are available on 44 percent of the loans included.

fCorporation for Enterprise Development, CDFI Data Project FY 2001.

gThe latest CDFI Data Project survey indicates all respondents surveyed
did not report on each data point requested. Therefore, these measures are
available on only 389 of all 512 CDFIs surveyed. CFED also disclosed that
they could not guarantee the reliability of the data.

hSBA quarterly reports for the 174 microlenders participating in SBA's
microloan program; and Aspen Institute, " Directory of U.S.
Microenterprise Programs," 2002, for the estimated number of microlenders,
totaling 554.

iEDA program data as of May 2003.

jData are collected but are maintained in hard copy at various regional
offices and, therefore, not useable.

kARC program data as of February 2003.

lNational Association of Development Organizations Biennial Survey data as
of March 2003.

mSBA 504 program data 2003.

nNational Congress for Community and Economic Development 1999 Census.

EDA and HUD recently completed one-time studies on RLF lenders, lenders
funded by Section 108 and CDBG, respectively, that included analysis of
loan-level performance data (see figure 2). In addition, the CDFI fund has
received and consolidated loan-level data as part of its ongoing Secondary
Market Feasibility Study. We attempted to obtain summary data from these
sources on the dollar amount and number of loans in default in order to
estimate a cumulative default rate for each program. Although CDFI Fund
does not collect default data, they recently began collecting loan-level
data and tracked information on loan write-offs. We, therefore, attempted
to obtain CDFI write-off data as a proxy for default measures. However, we
found that loan-level data from the CDFI Fund lacked data on the timing of
write-offs. This information was requested from the lenders in the study's
survey; however, only 10 percent of the reported loans included the date
of write-off. Without knowing the timing of defaults, it is not possible
to account for differences in default rates attributed to the age of a
loan. According to data provided by Rutgers University, non-real estate,
loans made by EDA/RLFs between 1988-1995

have, on a weighted average basis, a 4-year cumulative default rate of 4
percent.19 The ultimate default rate cannot be calculated until loans have
had an opportunity to reach maturity. Comparable data on HUD loans were
not available at the time of this report.

Where loan performance measures did exist in aggregate form, they were
defined inconsistently across lenders. For instance, delinquencies for
IRPs are defined as loans up to 90 days past the due date, whereas
delinquencies are defined for CDFIs as failure to make a payment as early
as 31 days and up to 90 days or more past the due date. Defaults for EDA
RLFs are defined as 60 days past due, but not written off; whereas, the
defaults for lenders supported by HUD's Section 108 and CDBG programs are
defined as more than 90 days delinquent with no further payments expected.

  As with the Lenders They Serve, Federal Programs Share Similar Missions, but
  Differ in How They Operate

We reviewed 11 federal programs that fund the seven CED lenders included
in our study. These programs are administered by EDA, Treasury, HUD, USDA,
SBA, ARC, and HHS.20 The programs have a similar purpose in that each was
established to improve economic conditions in communities considered
distressed or underserved. However, the programs differed in how they
achieved their purposes and the size and level of activity. Some programs
in our review have experienced budget reductions. We also found that
several programs have considered securitization as an option to increase
access to capital. Finally, few programs regularly collect information on
the performance of lenders and the loans they make. Consequently, little
information is known about the dollar volume or number of loans that some
of these federal programs have funded to support CED lending in
communities across the country.

19These data should be viewed carefully. Data on loan performance are
derived from semiannual reports prepared by RLFs. According to EDA
officials, use of RLF grant money may not be covered by RLF audits. We did
not assess the reliability of these data.

20HHS also administers the Community and Economic Development
Discretionary Grant Program. According to HHS officials, beginning in
2000, these grants may be used for funding RLFs. In 2002, HHS made fewer
than 10 grants to RLFs under this program.

Federal Programs Have Similar Purpose but Different Requirements and Forms
of Support

The 11 programs we reviewed were established to improve economic
conditions in distressed or underserved communities. However, the programs
differed in the form of federal assistance offered to CED lenders, and the
targeting of assistance to specific geographic areas, borrowers, or
businesses.

As noted in table 2, 6 of the 11 programs in our review helped fund CED
lending through grants only; one program used loans only; two used loan
guarantees only; one used a combination of loans and loan guarantees; and
another used a combination of grants, loans and equity investments. The
programs provide lenders with funds that may be loaned to borrowers and
the proceeds from repayments on the loans may be used to make additional
loans for community and economic development.21 All but one of the
programs allowed lenders to establish their own rates and terms.22 In
general, programs required that lenders' applications include a discussion
of how they planned to use the funds, which might include lenders'
targeting criteria for borrowers, interest rates, and terms. Finally, all
but the 504 CDC program receive some level of government subsidy.

21For the 504 CDC program, loan repayments go directly to investors and
are, therefore, unavailable for relending.

22SBA sets the interest rate on 504 CDC loans.

    Table 2: Federal Programs and Type of Assistance Provided to CED Lenders

                                                                         Loan 
                                   Federal program  Loan   Grant    guarantee 
                    Intermediary Relending Program   X            
                                             (IRP)                
                   Rural Business Enterprise Grant           X    
                                            (RBEG)                
                    Economic Adjustment Assistance           X    
                                 Program (EDA RLF)                
                      Business Development Program           X    
                    Revolving Loan Fund (ARC RLF)a                
                       Community Development Block           X    
                                      Grant (CDBG)                
                        Section 108 loan guarantee                     X      
                    Community Services Block Grant           X    
                                            (CSBG)                
                       Empowerment Zone/Enterprise           X    
                           Community Grant (EZ/EC)                
                    Financial Assistance component   X       X    
                                     of CDFI Fundb                
              10         504 Certified Development                     X      
                                 Company (504 CDC)                
              11         Microloan Direct and Loan   X                 X      
                                Guarantee programs                

Source: Federal program documents.

aARC is authorized to make loan guarantees but has not used this authority
in the last 13 years.

bAlso offers equity investments, deposits, and credit union shares.

o 	The seven grant programs we reviewed permit grantees to use funds for
operating RLFs, as well as for other economic development activity- for
example, acquisition or development of land, or provision of public water
and sewer facilities.23

o 	Two loan programs-USDA's IRP, and SBA's Microloan program-offer lenders
loans with low rates and relatively long repayment terms. For

23HHS's CSBG and EZ/EC programs are among these. According to HHS
officials, Illinois is the only state that uses HHS CSBG funds for the
purpose of economic development activities such as establishing RLFs.

example, IRPs receive loans at 1 percent interest to be repaid within 30
years. The low cost of the federal loan could enable the lender to pass on
low loan payments to borrowers. SBA's Microloan program makes loans to
lenders that lenders then use to make microloans to eligible borrowers.
Lenders may receive loans of up to $750,000 to be repaid within 10 years.
Each lender is limited to a maximum of $3.5 million outstanding at any one
time. SBA looks to the lending intermediary to pay its loans in full,
regardless of the payment history of individual borrowers. Borrowers,
unable to obtain credit from a traditional lending institution, also
benefit from the technical assistance to improve their business' chance of
success.24

o 	The three loan guarantee programs-HUD's Section 108 and SBA's 504
Certified Development Company (504 CDC) and Microloan programs- offset all
or a part of the credit risk of loans by providing participating lenders
with a loan guarantee on all or part of the loan payments in the event of
a borrower default. In the Section 108 program, the principal security for
the loan guarantee is a pledge by the applicant community or the state
(for nonentitlement communities) of its current and future CDBG funds.
Under the 504 CDC program, SBA guarantees loans made by 504 CDCs at market
interest rates to be paid over 10 or 20 years.25 The 504 CDCs provide
small businesses with fixed-rate, long-term loans, primarily for
buildings, land, equipment, and machinery (not to exceed 40 percent of the
total project cost). A private lender must provide at least 50 percent of
the project cost. According to SBA officials, the lenders benefit from
SBA's guarantee because they are in a first lien position, which lessens
their credit risk. Under the Microloan program, SBA guarantees loans that
are made to intermediaries by private sector lenders.

o 	Finally, the Financial Assistance component of the CDFI Fund offers
grants, loans, and equity investments to CDFI lenders. However, lenders

24SBA's Microloan program allows grant funds to be used only for technical
assistance and training of microborrowers and potential microborrowers.
According to SBA officials, such technical assistance is sometimes viewed
as a substitute for collateral and is intended to help ensure repayment of
Microloans.

25The 504 CDC makes its loans with proceeds from a guaranteed debenture.
Loan payments owed to the 504 CDC match the payments the 504 CDC owe
investors under the debenture. If the borrower defaults, SBA buys the
debenture back from the investors. Lenders must reimburse SBA for 10% of
the loss it incurs in connection with the 504 CDCs's default on the
debenture.

must obtain nonfederal matching funds in a form and value similar to the
CDFI Fund's award. For instance, a lender receiving a grant award from the
CDFI Fund must match the award dollar for dollar with other grant money.
Likewise, lenders receiving loan and equity awards must match the loan
dollar for dollar with other loan and equity money.

The programs also varied in whether and how they target geographic areas,
borrowers, or businesses. Table 3 illustrates the range of geographic
areas targeted by the programs in our review. For example, both USDA
programs target rural areas, the ARC program targets Appalachia, and other
programs target eligible areas that they define as economically
distressed.26 Similarly, table 3 shows that many of the programs we
reviewed require that eligible borrowers create jobs or otherwise improve
economic conditions in the areas that the borrower's business or project
will impact.27 Likewise, some programs have established target eligibility
criteria for borrowers that include credit qualifications. For example, in
EDA's Economic Adjustment Assistance Program, borrowers are not eligible
unless they are unable to obtain a loan with acceptable terms and
conditions from a traditional lending institution. Finally, some programs
limit eligibility to specific types of borrowers. For instance, SBA's
Microloan program requires that borrowers be small, for-profit
businesses.28

26Appalachia includes all of West Virginia and parts of 12 other states:
Alabama, Georgia, Kentucky, Maryland, Mississippi, New York, North
Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, and Virginia. The
term "economically distressed" is defined differently among programs. For
instance, EDA defines economically distressed as urban or rural
communities that are experiencing high unemployment, low per capita
income, and other conditions, including sudden economic dislocations due
to industrial restructuring and relocations or natural disasters. Other
programs may use different terminology to indicate targeted economically
distressed areas.

27ARC's Business Development program allows borrowers to be located
outside of the Appalachian region; however, the business or project to be
funded must provide jobs or other economic benefits within the region.

28A borrower may also use Microloan proceeds to establish a nonprofit
child care business.

Table 3: Summary of Programs and Their Target Market Criteria Targeting criteria

Job creation Geographic Low income and Borrower Federal program areas
populations preservation credit Types of entities supported

Intermediary Relending Program (USDA X   X  X       Start-up, expansion of 
                   IRP)                                   existing businesses 
     Rural Business Enterprise Grant    X   X          Start-up, expansion of 
               (USDA RBEG)                                existing businesses 
      Economic Adjustment Assistance    X   X  X       Start-up, expansion of 
      Revolving Loan Fund (EDA RLF)                       existing businesses 
Business Development Revolving Loan  X X X  X       Start-up, expansion of 
              Fund (ARC RLF)                              existing businesses 
    Community Development Block Grant     X      Various for-profit or        
                  (CDBG)                         nonprofit businesses         
        Section 108 Loan Guarantee        X      Various for-profit or        
                                                 nonprofit businesses         
                                          X Xa         Start-up, expansion of 
      Community Services Block Grant                                 existing 
                  (CSBG)                                  businesses          
          Enterprise Community/         X X X              Various            
      Empowerment Zone Grant (EZ/EC)             
    Financial Assistance component of   X X                Various            
                CDFI Fund                        
    504 Certified Development Company   X   X  X Small, for-profit businesses 
                (504 CDC)                        
Microloan Direct and Loan Guarantee  X X    X Small, for-profit businesses 
                 programs                        

Sources: Federal program documents and Catalog of Federal Domestic
Assistance.

aIllinois CSBG program requires borrowers to hire at least one new
full-time equivalent CSBG eligible employee for each $20,000, or any
portion thereof, of CSBG monies borrowed.

Federal Programs Differ in Size, Level of Activity

In general, as shown in table 4, programs ended fiscal years 1998-2003
with lower funding levels than they began. In the most recent three years,
the Section 108 and 504 CDC loan guarantee programs, which securitize CED
loans, have required less funding than most other CED programs. In these
years, the 504 CDC had no appropriations because the present value of the
estimated cash inflows from fees and recoveries equaled the estimated cash
outflows from claims. Table 4 illustrates the levels of appropriations for
those programs where data were available for fiscal years 1998-2003.

Table 4: Appropriations for CED Lending Have Declined in Selected Federal
Programs (Fiscal Years 1998-2003)

                              Dollars in millions

                                                                         2003 
                    Federal program   1998 1999  2000  2001   2002 (estimate) 
                     EDA-RLF Granta $29.9  $34.6 $34.6 $49.5 $40.9       40.6 
               Treasury-CDFI (FA) b   43.0 75.8  66.8  47.1   34.3       31.8 
               HUD-Section 108 Loan                                
                         Guaranteec    9.0 10.0  29.0  29.0   14.0 
                   SBA-504 CDC Loan                                
                         Guaranteec 166.0  34.0    5.0     0     0 
                      USDA-IRP Loan   17.0 17.0  17.0  19.0   13.0       20.0 
         SBA-Microloan Direct Loand      0   2.0   2.0   3.0   1.0 

Sources: Federal Budget Appendixes for 1998 through 2004 and federal
agency data.

Note: Six programs were unable to provide information on the dollar amount
of annual appropriations used to capitalize CED lenders. HUD CDBG
(State-Administered and Entitlement Cities) and HHS EZ/EC programs do not
allocate appropriations by type of activity (that is CED lending) funded.
The USDA RBEG program does not receive an earmark in appropriations for
RLF spending. RBEG recipients may use the funds for a variety of purposes,
including capitalization of an RLF. Appropriations for the HHS CSBG
program were not included because, as noted elsewhere in this section,
according to HHS officials, Illinois is the only state known to use CSBG
funds for CED lending purposes. ARC receives one appropriation to support
all administrative and programmatic activity. Hence, there is no budget
specifically for the Business Development Revolving Loan Fund program. The
appropriation is allocated amongst the 13 states, and the commission
decides to approve the funding for individual plans submitted by states
based upon how the proposed project meets the agency's mission strategy.

aOnly includes funds for RLFs that help communities adjust to sudden and
severe economic dislocation (SSED/RLFs), and long term economic
deterioration (LTED/RLFs). Does not include grant funds used for defense
and disaster assistance. Appropriated funds for these other types of
economic adjustment grants varies from year-to-year and has declined in
recent years.

bIncludes grants, loans, and equity investments made from the CDFI Fund.

cAppropriations for loan and loan guarantee programs are based on
assumptions regarding the performance of the loans. The ultimate cost to
the government could be higher or lower if actual loan performance differs
from these assumptions.

dAppropriations for the SBA Microloan loan guarantees were zero for all
fiscal years 1998-2002 and the 2003 estimate, except in fiscal year 2000,
when SBA did not report the budget authority for the program. However,
fiscal year 2000 outlays for the SBA Microloan loan guarantees were $1
million.

The federal programs we reviewed also differed in the number of lenders
participating in the program, ranging from as few as 35 lenders in ARC's
Business Development program, to as many as 546 in EDA's Economic
Adjustment Assistance RLF program. Most of the programs were able to
provide information on the number of lenders and the number and dollar
volume of program awards-whether loans or grants-made to CED lenders. HUD
CDBG and HHS EZ/EC and CED programs were the only

exceptions. The two loan guarantee programs, 504 CDC and Section 108,
issue notes that are sold to investors. The volume of loan guarantee
commitments is noted in table 5. We found that there was a great deal of
variation in the level of program activity between these programs.

Table 5: Number of Lenders and Dollar Volume of Federal Support (Fiscal
Years 1998-2002) a

FY 1998-2002b

                                                                Dollar volume
                                                 Number of lenders of support
                             Federal program (agency) supported (in millions)

               Intermediary Relending Program (USDA)    273            $167.5 
              Rural Business Enterprise Grant (USDA)    364              45.6 
               Economic Adjustment Assistance (EDA)c    546              24.4 
                  Business development program (ARC)    35               33.7 
                  Section 108 loan guarantee (HUD) d    N/A           1,800.7 
               Community Services Block Grant (CSBG-           
                                           Illinois)    38               49.0 
              Financial Assistance (FA) component of           
                               CDFI Fund (Treasury)e    N/A             267.0 
                               504 CDC program (SBA)    272          11,524.0 
               Microloan program Direct Loans (SBA)f    174             111.2 

Source: Federal agency data.

Note: N/A data is not available.

aFederal support may consist of grants, loans, loan guarantee commitments,
and other investments. For loans and loan guarantees, the amount shown is
the face value of the loan.

bBusiness development program (ARC) covers FY 1977 through February 14,
2003, and the Illinois CSBG program covers FY 1984-2002.

cData on the number of lenders supported by EDA's Economic Adjustment
Assistance program covers the period 1975-2002, and includes Disaster
Assistance and Defense RLFs. However, dollar volume amounts cover the
period noted in the table (1998-2002), and reflect grants made to SSED and
LTED RLFs only.

dA Section 108 grantee may reloan the proceeds of a loan guarantee to fund
loans to a third-party borrower either directly or through a nonprofit
intermediary (i.e., a RLF or CDC).

eCDFI's Financial Assistance includes core and intermediary component
programs. These amounts include grants, loans, deposits, and equity
investments.

fAmounts for SBA's Microloan program include support for direct loans
only, not loan guarantees.

Several Programs Have Considered Securitization

Several of the programs in our review have studied or are presently
undertaking securitization efforts. For example, Treasury's CDFI Fund
recently commissioned a survey of its CDFIs to study the feasibility of
developing the secondary market for loans made by its members. In 1999,
EDA initiated a demonstration project that provided financial assistance
to support RLFs wishing to securitize a portion of their loan portfolio.
The pilot resulted in three RLFs successfully securitizing or selling
loans. In addition to the Section 108 loans HUD currently securitizes, HUD
sponsored a study to collect extensive information on the loans made by
its CDBG and Section 108 awardees to third-party businesses and nonprofit
organizations, in part to assess the potential for creating a secondary
market for these loans. Other programs have made some efforts to determine
the feasibility of securitizing loans made by their lenders. In 1999, the
ARC program removed language from its guidance allowing its RLFs to sell
their loans. Officials noted that grantees were uninterested in
securitization for several reasons, including grantees' easy access to
additional capital through the ARC grants. After a successful sale of IRP
loans made in Colorado, in November 1999, USDA piloted a first attempt to
sell IRP loans nationally. According to USDA officials, the pilot
generated little interest because of the strict requirements for lender
participation. To date, USDA has not established formal regulations to
support securitization. SBA securitizes 504 CDC loans. Finally, our review
also found that some programs have prohibitive or inhibitive program
requirements governing the use of the funds that limit lenders' ability to
securitize their loans. We address this issue in more detail later in the
report.

Federal Programs Vary in Efforts to Collect and Maintain Information on
Lender Activity and Loan Performance

The programs differed in the type of information they collected on lender
activity, the performance of lenders' loan portfolios, and how the
information was maintained. Information that lenders were required to
report also varied widely. For example, the CDFI Fund requires lenders to
report on the amount, number, and type of loans that CDFI lenders make. In
contrast SBA's Microloan program required information on account activity
supported by bank statements, as well as an account of the status of each
loan in the portfolio. Other items that some programs required lenders to
report included the financial condition of the lender and impact
information-such as the number of jobs created and retained.

In addition, the frequency of reporting required by lenders differed by
program. Three programs-USDA's IRP, RBEG and SBA's Microloan-

required that lenders submit quarterly reports; two programs-EDA RLF29 and
ARC's Business Development-required semiannual reports; and six- 504 CDC,
CDBG, EZ/EC, CSBG, CDFI, and Section 108-required annual reports.

Further, our review found that regardless of how data are collected, there
is little information about the volume of lending activity supported by
and loan performance of some of the programs in our review. Programs in
EDA, ARC, and Treasury required that lenders provide ongoing information
on the loans in their portfolios, often including the loan amount, term,
interest rate, and losses.30 However, as mentioned earlier, they are not
consistently defined, and do not all contain information at the
loan-level. Further, four of the programs in HUD, EDA and Treasury only
recently began collecting loan-level information because they undertook
one-time, loan-level data collection efforts.31

Finally, these programs differed in whether they maintained performance
information on paper or in a database and whether the files were kept in a
central location or office. Only programs in Treasury maintained lender
and loan information in a database, and only programs in ARC and Treasury
maintained annual report information on lenders and their loans in a
central location.32

29However, grantees can graduate to annual reporting upon consent of the
agency.

30The only exception to this is the CSBG program. According to HHS
officials, Illinois is the only state in the country that uses CSBG funds
for economic development lending purposes. The program has 38 local
Community Action Agencies operating RLFs. The program administrator told
us that he is intimately familiar with the lenders and their loan
portfolios. As indicated in figure 2, performance data for CDFIs is
currently collected at the aggregate level. However, Treasury has recently
proposed that CDFIs report performance information annually at the loan
level.

31In providing comments on the report, HUD officials informed us that
while they do not get information on loan performance data targeted in our
report, HUD's Integrated Disbursement and Information System includes
information on the type of assistance provided and the terms of assistance
including interest rates and amortization periods.

32The Illinois CSBG program also maintains data on lender activity in a
database in a central office. We were unable to document the extent to
which SBA maintains data on loans made by lenders supported in its 504 CDC
program and Microloan programs.

  Selected Securitization Models for Small Business and CED Loans Have
  Similarities and Differences

We reviewed five existing and three proposed securitization models
designed to provide greater access to capital for small business and CED
lenders. Each of the eight models exhibit similarities and differences in
terms of (1) the types of lenders and borrowers served, (2) the types of
loans pooled and methods for pooling, (3) the distribution of financial
benefits and risks among participants, and (4) their outstanding
securitized volumes. Less is known about the proposed securitization
models since they do not currently engage in market transactions.

Types of Lenders and Borrowers Served Vary

As shown in table 6, these models serve, or would serve, private,
nonprofit, and governmental lenders. For example, the two models
securitizing SBA's 7(a) guaranteed and unguaranteed loans serve mostly
depository lenders such as commercial banks and some nondepository lenders
such as finance companies. The SBA 504 program serves only private
nonprofit corporations called CDCs, while the existing and proposed
Section 108 models serve or would serve CDBG-funded state and local
governments and development agencies. The Community Reinvestment Fund
(CRF) may serve nonprofit, for-profit, and governmental community
development lenders eligible to sell loans. Similarly, the proposed CDA
model would serve those lenders eligible to sell loans.

Table 6 also shows a wide variety of borrowers served by these models. For
example, the SBA 504 model finances small businesses who have qualified
for conventional loans backed by commercial real estate loans with senior
bank participation, whereas the CRF model has provided financing to
businesses ranging from start-up microenterprises to marginal for-profit
and nonprofit borrowers. While all models generally loan to for-profit
businesses, some are restricted to small businesses (SBA models) and
others may also serve nonprofit borrowers (CRF and Capital Access models).

Table 6: Securitization Models and Lenders and Borrowers Involved

Model Lenders Borrowers

SBA 504 Program Certified Development For-profit small businesses that

                              guaranteed Companies

have qualified for conventional loans

 SBA 7(a) guaranteed Commercial banks, credit For-profit small businesses that

unions, small business lending companies and other nonbank lenders

have demonstrated they could not obtain financing without the 7(a) program
SBA 7(a) Commercial banks, credit For-profit small businesses that

unguaranteed	unions, small business lending have demonstrated they could
companies and other nonbank not obtain financing without the lenders 7(a)
program

          HUD Section 108  CDBG grantees and their For-profit or nonprofit    
                                                   borrower                   
               guaranteed       designated lenders 
                            Nonprofit, for-profit, Local business, affordable 
                Community                      and 
        Reinvestment Fund governmental CED lenders housing, and community     
                                                   facility                   
                    (CRF)                                           borrowers 
                            Nonprofit, for-profit, Small business borrowers   
                 Proposed                      and not                        
             Commonwealth governmental CED lenders served by local commercial 
              Development                              financial institutions 
         Associates (CDA)                          
                                                   For-profit or nonprofit    
                 Proposed  CDBG grantees and their borrower                   
               CDBG / 108       designated lenders 
             unguaranteed                          
                                      CDFI lenders Minority businesses,       
                 Proposed                          nonprofits,                
           Capital Access                              commercial real estate 
        Program variation                          

               Sources: SBA, HUD, CRF, CDA, Capital Access Group.

Types of Loans Pooled and Methods for Pooling Vary

These models securitize a variety of loan products to serve the borrowers
and lenders described above. Table 7 details similarities and differences
in the type and characteristics of loans that may be pooled in each model,
including loan purpose, collateral positions, loan terms, and rates. For
example, while each of the models accepts commercial real estate and
business equipment loans into their loan pools, the models vary in their
acceptance of working capital and community facility loans. Additionally,
senior or subordinate collateral positions on these loans vary by model.
For instance, the two SBA 7(a) models prohibit subordinate loans, while
the SBA 504 and Capital Access models allow only subordinate loans. One
proposed model, CDA, would only purchase seasoned loans rather than
committing in advance to securitizing loans meeting certain underwriting

standards. Terms of the loans that each model may accept vary slightly;
all of the models would purchase long-term loans between 10 and 20 years,
but only one model-the SBA 504 model--does not purchase loans with
maturities less than 10 years. Variation in loan rates also exists. For
instance, all of the models allow fixed-rate loans to be purchased, but
three of the models prohibit variable-rate loans. Most of the loans
securitized by the two SBA 7(a) models included variable-rate loans. Four
of the models purchase or would purchase only market-rate loans. Two
purchase or would purchase market and below-market-rate loans, and the
remaining two models purchase below-market-rate loans only. While data on
average loan size was not readily available for most models, the two
models that provided this information demonstrated a wide divergence in
average loan sizes: $165,000 for the SBA 7(a) loans in fiscal year 2003
compared with $1.5 million for the Section 108 Loan Guarantee program
since 1995.

         Table 7: Types of Loans Pooled Varies by Model Proposed models

      Capital AccessHUD Section 108 guaranteed Community Reinvestment Fund
 Commonwealth Development Associates CDBG / SBA 504 Program SBA 7(a) guaranteed
                             SBA 7(a) unguaranteed

Section 108

                        program variation Types of loans

        Commercial        Xa      X      X      X      X      X     X       X 
       real estate                                                      
        Community                                      X                
        facilities                                                      
         Business         Xb      X      X      X      X      X     X       X 
        equipment                                                       
     Working capital              X      X      X      X            X       X 

Loan position

        Senior                 X      X      X      X      X      X    
      collateral                                                       
       position                                                        
        Junior         X                     X      X      X      X         X 
      collateral                                                       
       position                                                        

(Continued From Previous Page)

Proposed models Capital Access SBA 7(a) unguaranteed HUD Section 108 guaranteed
 Community Reinvestment Fund Commonwealth Development Associates CDBG / SBA 504
                          Program SBA 7(a) guaranteed

Section 108

                        program variation Loan maturity

Less than 10 X X X X X XX years

                         10 to 20 yearsXc X X X X X X X

                   Loan interest rates Underwriting criteria

         Fixed         X      X      X       X      X      X      X         X 
       Variable               X      X      Xd      X                  
      Market rate      X      X      X              X      X                X 
     Below market                            X      X      X      X    
         rate                                                          

Advance loans X X X unknown X

Seasoned X X X X X unknown loans

Sources: SBA, HUD, CRF, CDA, Capital Access Group.

a90 percent of all loans. b10 percent of all loans. c90 percent of loans
are 20 years. dFor interim financing only.

Only SBA's 7(a) models and CRF hold loans on balance sheets of the pool
assemblers until they assemble enough loans to pool and securitize. Other
models predetermine the timing of their securities issuances, and
sometimes their loan originations, in advance. For example, SBA's 504
program anticipates regular and predictable monthly issuances of its
20-year securities backed by CDC-originated, SBA-guaranteed loans. The
Section 108 Loan Guarantee model also issues notes to investors in a
regular and predictable manner-each year at the beginning of August. In
between these public offerings, HUD provides interim variable-rate
financing to CDBG grantees through a money market fund in Pittsburgh.
(Appendix II contains brief descriptions of the structures for each
securitization model.)

Distribution of Risks and As explained in the following sections, models
distribute interest rate risk Benefits Vary among Models (the risk of
financial loss due to changes in market interest rates) and

Interest Rate Risks Are Distributed Differently

Credit Risks Are Distributed Differently

credit risks (the risk of financial loss due to borrower default) among
various participants differently. Benefits of various securitization
models also vary among participants.

The models distribute interest rate risk differently among participants,
depending on whether loans allowed in the loan pool are fixed-rate or
variable-rate, whether or not loans are held for extensive periods of time
by lenders and loan pool assemblers until they can be sold (warehousing)
to investors, and how these participants fund the loans they hold.
Interest rate risk for lenders, loan pool assemblers, and investors
depends on the terms to maturity of their own assets and liabilities, and
their interest rates. For example, an investor in a long-term, fixed-rate
asset would not face interest rate risk if this asset was funded with a
long-term, fixed-rate liability with the same term. Such asset funding
would lock in an interest spread (interest earned on the asset or interest
paid on the liability) and negate the impact of interest rate movements on
earnings. However, an investor that funds long-term, fixed-rate assets
with short-term liabilities would face interest rate risk because a future
increase in interest rates could require the investor to roll over the
short-term liability when it came due into a higher-rate, short-term
liability and narrow or reverse the interest rate spread. Similarly, a
variable-rate asset if funded by a variable-rate liability with a lower
rate would curtail interest rate risk. However, funding a variable-rate
asset with a fixed-rate liability would create interest rate risk. A
future increase in the variable rate on the liability above the fixed rate
on the asset could create a negative spread. Borrowers of variable-rate
loans could find their cost of borrowing becoming less affordable if
interest rates increased, but could benefit from declines in interest
rates. Borrowers of fixed-rate loans benefit when interest rates rise, but
because business borrowers typically are penalized for prepaying loans,
they may not benefit from declines in interest rates.

Credit risk is also distributed differently among participants in the
models we reviewed. Investors assume limited or no risk relative to other
participants, depending upon the amount and type of credit enhancements
included in each model. As shown in table 8, all models use some form of
internal (assumed by the lender, borrower, or securitizer) or external
(third-party) credit enhancement to determine the credit risk assumed by
all participants. The three models where the federal government assumes
all credit risk require no additional internal or external credit
enhancement. The five models where the federal government takes little or
no credit risk result in other participants (usually lenders) assuming
credit risks through internal credit enhancements. CRF uses, and CDA
proposed,

multiple internal and external credit enhancements. CRF, a nonprofit, uses
foundation grants and program-related investments to fund some of its
credit enhancements.33 The CDA model envisions a similar credit
enhancement structure using public or private funding. Finally, while the
Capital Access model does not specifically propose a publicly funded
credit enhancement, virtually all 20 states that currently have Capital
Access lending programs do provide state funding to loan loss reserve
funds assigned to each participating lender, which may be used as credit
enhancements if authorized by state law.

Credit enhancements can take a variety of forms. External credit
enhancements rely on third parties to provide additional assurance of
timely payment of principal and interest to investors. These enhancements
can be governmentally provided (for example, loan guarantees) or privately
provided (for example, loan guarantee insurance or letters of credit).
With external enhancements, the credit quality and expected performance of
the asset pool is often based on the credit quality of the external
enhancement provider. Internal credit enhancements are not dependent on
third parties and are often funded by lenders. These enhancements include
senior or subordinate positions, in which cash flows from the pool of
assets are structured so that the higher credit quality "senior"
securities would fail to receive timely cash flows only after lower credit
quality subordinated securities fail to receive their cash flows. Internal
enhancements also include over-collateralization, in which the face value
of the assets in the pool are greater than the face value of securities
issued; excess spread, in which the difference between the cash flowing
into an asset pool and the cash flowing out of a pool to security holders
is set aside in a reserve fund to cover future, unexpected payment delays
or losses; and loan loss reserves, in which monies are set aside to cover
future unexpected cash flow delays or losses. Occasionally, such as with
CRF, loan originators may be required to replace nonperforming loans with
performing loans according to loan substitution agreements. Lender
recourse are financial obligations of lenders to make a loan pool whole if
the portion of the loan pool provided by that lender fails to perform.

33Program-related investments include loans, loan guarantees, mortgage
investments, and equity investments that are made by foundations such as
the Ford Foundation or MacArthur Foundation for many CED purposes, to
multiple CED entities. The foundation can receive favorable tax treatment
from the IRS if the Program-related investments receive below-market-rates
of return. Program-related investments can provide financial benefits to
the foundation, as well as further the mission of the foundation and the
receiving CED entities.

Table 8: Credit Enhancements Used to Distribute Credit Risks Vary by Model

Proposed models Common-

  Capital Credit enhancement type SBA 504 Program SBA 7(a) guaranteed SBA 7(a)
unguaranteed HUD Section 108 guaranteed Community Reinvestment Fund wealth
       Development Associates CDBG / Section 108 Access Program Variation

External

                              Governmental X X X X

                                  Private Xa X

Internal

Senior / subordinate                   X              X       X        X     
Overcollateralization                                 X       X              
    Excess spread                      X                                     
  Loan loss reserve                                           X        X        X    
 Recourse to lender                                   X                      
  Loan substitution                                   X       X              
                                    Public                                           
 Private or publicly  Public Public   or    Public Private Private    Not    Private
       placedb                      private                        specified 
    Credit rating       No     No     Yes     No     No      Yes      Yes         No 

Sources: SBA, HUD, CRF, CDA, Capital Access Group.

aIn addition to external foundation monies, CRF may attempt a rated
security that will include some external guarantee insurance on the senior
tranche securities.

bPublic offerings of securities must meet Securities and Exchange
Commission (SEC) registration and disclosure requirements. In a private
placement, securities issuers can avoid the costs of the registration and
reporting process required of a public offering as long as there is no
solicitation of the public, the investors are sophisticated in business
matters, and investors have access to certain information.

Benefits Are Distributed These securitization models distribute benefits
differently among

Differently	participants. Investors can diversify their portfolios with
new securities that have desirable risk, return, and maturity
characteristics. For example, a number of institutional investors,
particularly state or local and religious pension funds have been
investing in "socially responsible" investments for over two decades,
provided they could achieve market-rate returns with sufficient loss
protection to satisfy their "prudent person" investment

requirements.34 As noted earlier, pension funds hold longer-term,
fixed-rate investments for portfolio management purposes. These models
provide lenders opportunities to better manage their risk and financial
positions by selling certain loans they have originated from their
portfolios and to further their missions by replenishing capital available
for new loans or other purposes. For example, CRF's ability to warehouse
CED loans improves CED lenders' ability to sell loans on occasions when
the benefits of selling the CED loans are most clearly visible to CED
lenders. SBA's attempts at regular and predictable monthly issuances of
its securities backed by SBA-guaranteed 504 loans allows a more consistent
mechanism for 504 CDCs to sell loans, rather than hold long-term loans in
their portfolios thereby freeing their capital for other purposes.
Borrowers in each of the models benefit from access to capital that would
otherwise be unavailable.

Volume of Outstanding Securitized Loans Have Not Reached the Volume of
More Well-Established Models

Figure 3 shows the total amount of outstanding securitized loans for
well-established securitization models versus models for securitizing CED
loans. Models with assets such as home mortgages, commercial mortgages, or
consumer financings show the greatest amount of outstanding securitized
loans. These models have been in existence for many years. Conventional
home mortgages, for example, have been securitized for over 30 years.
These industries have developed standards for documents and underwriting
that enable wider securitization. The existing CED models we reviewed have
not reached the level of securitization of the more well-established
models. Among the CED models, the two SBA guaranteed models have a far
greater amount of outstanding securitized loans than the other three
models-7(a) unguaranteed, Section 108 guaranteed, and CRF.

34Prudent person rules allow investment managers or fiduciary trustees the
flexibility to make financial decisions regarding asset-types and rates of
return that an ordinary, reasonably well-informed person would exercise.
Prudent person rules tend to discourage speculative transactions, placing
the potential for higher incomes and capital gains in a secondary position
to preservation of capital.

Figure 3: Levels of Outstanding Securitized Loans Have Not Reached the
Levels of More Well-Established Models

3,500

3,000

2,500

2,000

1,500

1,000 500 0

                                       de

Federally relatedeggat

home mor

ab

poolsPrivate homeeg

tgamor

pools	cial eg

Commerga

A 7(a)SB

A 7(a)SB

i

                                   Community

Consumer creditsA 504 debenturesSB

f

                                guaranteed loans

h

Reinvestment Fundunguaranteed loansguaranteed loans

                                       g

c

-backedsecurities

tmorWell-established models Less-established models

Sources: Federal Reserve Board, SBA, CRF, and HUD.

aFederal Reserve Bulletin, Table A33, July 2003. Outstanding principal
balances of Federal National Mortgage Association (Fannie Mae), Federal
Home Loan Mortgage Association (Freddie Mac), and Government National
Mortgage Association (Ginnie Mae) guaranteed or insured mortgage-backed
securities. Includes one- to four-family mortgages.

bFederal Reserve Bulletin, Table A33, July 2003. Outstanding principal
balances of mortgage-backed securities issued through private mortgage
conduits. Includes one- to four-family mortgages.

cFederal Reserve Bulletin, Table A33, July 2003. Outstanding principal
balances of nonfarm, nonresidential, mortgage-backed securities issued
through private mortgage conduits.

dFederal Reserve Bulletin, Table A34, July 2003. Includes outstanding
balances of all pools of securitized credits, including revolving and
nonrevolving credit.

eSBA reported data as of September 30, 2002.

fSBA reported data as of September 30, 2002.

gSBA reported data as of September 30, 2002. This number represents loan
balances at the time of securitization, not outstanding loan balances as
of September 30, 2002.

hHUD reported data as of August 29, 2003.

iCRF reported data as of December 31, 2002. This number represents loan
balances at the time of securitization, not outstanding loan balances as
of December 31, 2002. This number excludes notes

backed by roughly $41 million (loan balances at the time of
securitization) of CED loans that were not issued through a special
purpose vehicle. As of December 2002, these notes had an outstanding
principal balance of about $1 million.

  We Identified Barriers to Securitizing CED Loans

We identified six categories of barriers for either lenders or capital
markets investors in securitizing CED loans. First, uncertain borrower
demand exists across targeted markets, and CED lenders generally lack
incentives to participate in securitization. Second, management capacity
for securitizing loans is limited. Third, external requirements attached
to funding sources may directly or indirectly inhibit the securitization
of CED loans. Fourth, CED lenders believe that selling below-market-rate
loans would require them to absorb too high a discount to profit from a
securitization. Fifth, lack of lender product standardization,
documentation, and loan performance information impedes securitization by
increasing transaction costs. Finally, mechanisms available to support
securitization for CED loans are limited.

Uncertain Borrower Demand and Limited Lender Interest Limit the Ability to
Securitize

According to studies, lenders, programs, and their associations, current
and future borrower demand is not understood across target markets, and
CED lenders do not see the benefit of securitization. Borrower demand-
borrower's need for capital in target markets served, given the risk
levels lenders can absorb-is not understood by lenders, programs, and
capital market participants across target markets because it can be
volatile and is not consistently measured. In some federal programs, for
instance, measurements of current borrower demand are assessed through
lender annual reports. Other programs and their lenders also use proxy
measurements of demand.35 In addition, there are no mechanisms or
standards for forecasting future borrower demand for such loans, making it
difficult to determine what borrower demand might be across markets.
Moreover, borrower demand is unpredictable, in part due to changes in
local conditions in some markets. For some targeted communities, the
favorable economic climate of the 1990s prompted conventional lenders to
move down market (that is, lend to more risky borrowers), thereby pushing
demand for CED loans into areas where CED lenders were less willing to
take on further risk.

35For example, CDFI 's trade association noted a "deployment rate," which
is used as a proxy for the percentage of loanable funds that are actually
loaned out.

According to several CED lenders, securitization studies, and reviews of
federal agency securitizations, lenders lack incentive to participate in
securitizations. For instance, EDA's securitization pilot study found that
the primary barrier to securitizing RLF loans stemmed from the fact the
lenders did not want to sell their loans.36 According to key officials
knowledgeable about one of the four demonstration projects, lenders did
not find the deal attractive because they had access to cheaper capital
through the EDA grant program. Additionally, lenders would not commit
loans for sale into the loan pool in advance because they were unsure
whether good borrowers would be available to whom they could relend the
sale proceeds. Also, the Department of Commerce's Office of Inspector
General recently found that some RLFs funded by EDA were carrying
excessive capital reserves and required them to return these funds to the
program, and that EDA monitor the RLF to ensure continued compliance.
These lenders would not need the liquidity benefits from securitizing
their loans. According to program officials in ARC, lenders funded by ARC
do not wish to securitize their loans and are now prohibited from doing
so. Officials explained that there were a number of reasons why ARC
grantees did not want to securitize including loss of interest on loans
they hold; limited yields accrued from securitizing their loans; and
limited need for liquidity given readily available grant funding they
receive through the ARC program. Preliminary results from the Department
of Treasury's secondary market feasibility study indicates that while
about one-third of the respondents have sold at least some loans they
originated, CDFI participation in the secondary market for loans remains
small. Many of the markets have not traditionally worked with CDFIs
because of the small typical size of the CDFI loans, their nonstandardized
loan portfolios, and concerns about the lenders' ability to meet
loan-servicing requirements. About 23 percent of the respondents reported
not knowing enough about the secondary market to participate. USDA piloted
an effort to securitize IRP loans in 1998 but, according to program
officials, it failed because the requirements for participation were too
restrictive for most of the lenders to meet. For example, lenders who
could not demonstrate an ability to repay the entire principal balance on
their loan to USDA were ineligible to participate in any sale of the
assets from their portfolios. HUD's Section 108 loan guarantee program,
one of our five existing securitization models, is proposed for
elimination in fiscal year 2004, according to the Office of

36Kelly Robinson, "Expanding Capital Resources for Economic Development:
An RLF Demonstration." (Washington D.C.: Economic Development
Administration, 2001).

Management and Budget.37 A recent HUD study cited the program's collateral
requirements and lengthy approval process as the two major reasons for
declining program usage. 38 Senior HUD program officials cited the
elimination of the Economic Development Initiative (EDI) program as the
principal reason for the decline in use of the Section 108 program in
fiscal year 2001. Although the volume of lending has increased since that
time, it has not returned to the pre-2001 loan volume level.

We identified other reasons for the lack of lender interest in the
securitization efforts described above. First, the benefits of
securitization are not always clear to lenders. Second, as indicated
earlier, some of the lenders depend on income streams generated by their
portfolios, making it difficult for some of them to sell portions of their
portfolios. CED lenders that do not diversify their portfolios are
particularly vulnerable to interruptions in the stream of income coming
from a smaller pool of loans. During favorable economic times, the market
in which CED lenders operate is pressured by competition from conventional
lenders, thereby diminishing the demand for CED loans. While a number of
securitization efforts have been undertaken, given uncertain borrower
demand for CED loans and limited lender interest in securitizing loans, it
is uncertain what volume of CED loans might be available for
securitization on a wide scale. Without greater certainty, capital market
participants do not have a reason to invest in developing a market for
securitizing CED loans.

Insufficient Capacity Limits Lenders' Ability to Participate in
Securitization

Limited lender capacity-constrained by factors such as reliance on small
portfolios, insufficient financial information, and an insufficient number
of staff or inadequate staff skills-limits some lenders from being able to
participate in securitization. Many CED lenders' portfolios contain only
or mostly small loans. For instance, the average loan size for
microlenders is $11,600. In addition, lenders work extensively with their
borrowers to help them qualify for loans. This requires more time than
required to make

37A review of trends in HUD's unexpended balance report shows expiring
balances in the program going from $22.6 million in 1997 to $109.2 million
in 2001. These were 1-year appropriations that were not used at the end of
the period. According to HUD, for the past several years, the actual
demand for the program has been substantially below the loan guarantee
level requested or provided in appropriations. HUD also recognized that
grantees have not utilized the program at higher levels in part because of
their reluctance to pledge future grant funds as collateral.

38These collateral requirements refer to the additional security Section
108 borrowers must provide beyond the pledge of future CDBG program funds.

conventional loans and is often necessary to ensure borrower success.
Although lenders operate this way to meet their mission, one study
indicates it results in higher per loan costs, which in turn can increase
the subsidy required on each loan financed.

According to studies, lender trade associations, and private-sector
officials, lenders do not have sufficient financial information to
determine how much of a discount they could absorb. To ensure that an
asset an investor purchases provides market yields, capital market
participants require lenders to sell loans at a discount to at least cover
the additional risk- including interest rate risks and credit risks-they
might incur from securitizing loans. Lenders might benefit from
securitization if they could sell their loans at a price that best met
their current financial needs. However, according to trade and program
officials, some lenders do not have adequate financial information to
determine whether a given price is or is not in their best interest, given
the discount they would have to absorb in the sale. For instance, some may
not know how much it was costing them to originate and service these loans
and the income they could expect to earn from these loans. With better
information, lenders would be better able to determine whether the
discount being requested was appropriate and beneficial, given their
knowledge of the performance and value of the loans in their portfolios.

In addition, studies and lender trade associations indicate lenders lack
sufficient staff and staff with appropriate skills to manage the increased
activity they believe securitization would create. According to a Ford
Foundation study on CDFIs, many of these CED lenders offer salaries and
benefits that are significantly lower than those attached to jobs with
similar responsibilities and scope in the private sector.39 As a result,
these lenders may have a hard time competing for highly qualified and
desirable candidates. Further, lender trade associations with whom we
spoke noted that many CED lenders lack staff with the expertise to manage
the increased workload lenders might incur from portfolio sales. In
addition, some CED lenders experience difficulty originating and servicing
loans, including working out impaired loans, in a timely manner because
staff lack expertise and experience. The uncertainty about lender
experience is factored into the discounts charged by the markets. The Ford
Foundation

39 Brody, Weiser, Burns Business and Organizational Consulting, Strategies
to Increase Community Development Finance-a Ford Foundation CDFI, Study
Phase II, January 2002.

study notes that while these impediments tend to be true across a range of
CDFI lenders, the extent of these impediments vary by lender. For example,
many of the larger loan funds have been able to increase salaries enough
to have significant success in attracting staff from banks and other
financial institutions, while the smaller loan funds have had much less
success in doing so.

External Requirements May Prevent or Serve as a Disincentive for
Securitization

Lenders receive funds from various sources and must comply with the
various requirements or laws governing how the funds must be spent. These
requirements may negatively impact CED lenders' ability to sell their
loans to third parties, ultimately preventing securitization. The impact
could be direct or indirect. For example, some CED lenders receive funds
from more than one federal source and often underwrite loans to different
specifications, as determined by the various federal regulations governing
the funds. Disparate external requirements indirectly impact
securitization because they serve as a disincentive for CED lenders to
develop standard underwriting procedures, thus increasing the difficulty
and costliness of structuring a securitization.

Several federal programs offer illustrations of how lending requirements
may inhibit securitization. Some CED lenders reject the idea of
securitizing loans made with federal funds because some federal programs,
such as EDA, require that lenders use the proceeds on the sale of a loan
to make subsequent loans with the same purpose. For example, an EDA RLF
selling a disaster assistance loan would have to use the proceeds on that
loan sale to make additional loans for disaster assistance. In addition,
lenders in HUD's CDBG program that wish to sell their loans must ensure
that the buyer will uphold requirements to meet HUD national objectives.40
Some requirements have a direct impact on lenders' participation in
securitization. For example, ARC prohibits CED lenders in its program from
selling the loans they make with ARC funds.

40These national objectives include benefiting low- and moderate-income
persons, preventing or eliminating slums or blight, and addressing
conditions that pose a serious and immediate threat to the heath and
welfare of communities served.

Lenders Believe Below-Market-Rate Products Will Not Meet Market
Requirements without Substantial Discounts

CED lenders' missions, along with the purpose behind the supporting
federal programs largely dictate the loan products and services lenders
offer. As such, CED lenders generally offer below-market interest rates or
other flexible, nonconforming loan terms to small businesses that are
generally unable to obtain reasonable credit terms from traditional
lending institutions. Capital markets require discounts when securitizing
below-market-rate loans so that the effort will result in investments with
market yields, cover transaction costs associated with securitization, and
offset the uncertain performance of the underlying asset. To cover
potential credit concerns, capital markets may also require that lenders
provide a credit enhancement to offset the uncertainty of loan
performance. Some lenders believe that the discount or credit enhancement
that investors would require for securitizing their loans would be too
great. Some report that capital market investors would require higher
discounts than they would for securitizing other assets because CED loans
are not well understood. On the other hand, some federal program officials
fear that should securitization become an option for CED lenders to obtain
additional capital, lenders would shirk their mission in favor of lending
to more conventional borrowers.

Even if lenders were only required to accept a discount to offset the
below-market interest rate, they have a disincentive to sell their loans.
When holding loans, lenders account for the value of loans by using the
unpaid principal balance, less any allowance for loss-called net book
value. However, if a lender were to sell a loan, it would have to
recognize as a loss the difference between the sales price and net book
value. When purchasing below-market-rate loans, investors would require a
sales price below the unpaid principal balance to obtain a market
yield-requiring lenders to recognize a loss and creating a disincentive to
sell loans. In effect, selling loans would require a lender to recognize
the market value, rather than the higher book value of their loans.

Lack of Standardization and Inadequate Performance Information Inhibit
Securitization

CED lenders currently operate independently of each other, resulting in
nonstandard loan underwriting, documentation, and servicing. CED lenders
also lack an infrastructure for consistently recording the performance of
lenders and loans. As mentioned previously, the sources of capital and the
missions of CED lenders encourage CED lenders to underwrite and service
loans tailored to meet the unique needs of borrowers in their communities.
CED lenders also use varying definitions and documents and utilize
differing servicing policies. Additionally, CED

lenders have difficulty providing sufficient and consistent performance
information in a useable way. For example, few lender groups have a
facility for aggregating current loan-level performance information across
lenders. Lender reporting may or may not be automated, and the performance
data reported are not defined consistently across lenders.

Investors in securitized financial assets generally require reliable
assurances that the securities will pay interest and principal fully and
in a timely manner despite the performance of the overall economy. Credit
ratings from agencies such as Moody's or Standard & Poor's can often
provide these assurances. Additionally, securitizations require a credit
rating in order to be considered "investment-grade" and attractive to
institutional investors.41 Credit ratings play an important role in
determining how the securities should be structured and priced to appeal
to investors, including feedback on any levels of credit enhancement that
may be necessary to achieve a desired structure. Securities raters examine
certain characteristics of proposed securitizations in order to provide
their assessment of the performance of a pool of assets and ultimately
their credit rating as follows:

o 	Rating agencies examine current and historical loan and lender
performance data such as delinquencies, defaults, and losses to assess the
expected performance of a pool of similar loans over time.

o 	Rating agencies examine originator and servicer characteristics such as
management and financial strength, servicing and collection practices,
back-up servicing, workout and liquidation policies, and data processing
and reporting to assess originators' and servicers' capability to execute
their functions adequately and in a timely manner.

o 	Rating agencies examine the legal structure of the transaction to, for
example, assure investors that the pooled assets have been properly sold
to the bankruptcy-remote vehicle.

Generally, the larger the number of similar loans included in a loan pool
(that is, loans with more homogeneous loan underwriting, documentation,

41Many institutional investors, such as banks and pension funds are
generally restricted to "investment-grade" securities (nonspeculative
securities with higher credit ratings). One hundred percent governmental
guarantees can also provide adequate assurance to institutional investors
without a credit rating on the pool of assets. Investors willing to take
on more risk can invest in lower-rated, or nonrated securities.

and servicing) the less costly securing a rating can be.42 Additionally,
better and consistent data can reduce the costs of securing a rating and
allow for more precise estimates of performance, also providing for
accurate assessments of any required internal credit enhancements.43 The
variety of CED lender practices and inadequate performance information
prevent or inhibit capital markets from satisfactorily understanding the
performance of CED loans and increase the transaction costs involved with
assessing performance. The benefits of securitization are greatly reduced
for CED lenders to the extent they must fund any extra transaction costs
for these services, as well as fund credit enhancements to cover
unexpected losses that capital markets cannot satisfactorily profile.
Proposals to reduce these costs through standardization are viewed by many
CED lenders as contrary to their missions.

Limited Mechanisms Available to Support Securitization for CED Loans

According to trade association representatives and other interest groups,
if securitization is to become a viable alternative for lenders,
information-sharing and securitization mechanisms are needed to provide
consistent avenues for lenders to sell their loans, achieve the volume of
loans needed for a securitization, and achieve quality control. That is,
lenders have no apparent and available network or facility from which to
draw if and when selling loans. Likewise, investors have no apparent
facility or entity from which to purchase securities backed by CED loans.
In contrast to other mortgage-backed and asset-backed securitizations,
there is no comprehensive mechanism for sharing information with
interested lenders, investors, and capital market intermediaries. Ad hoc
networks, lender trade associations, and investor organizations do exist,
but they do not provide updated and comprehensive data and information on
a regular basis regarding loan volume. Neither do they provide a list of
interested lenders, potential investors, securitization mechanisms, and
credit enhancement providers.

Existing securitization mechanisms are limited in two different ways.
First, there are few mechanisms available to securitize small business and
CED

42Securities raters have traditionally required at least several hundred
similar loans or assets in a pool in order to create a risk profile for
the pool using statistical analysis. Statistical analysis is generally
more cost-effective for securities raters on a per loan basis than other
methods of analysis.

43Many securitizations require originating lenders to assume first-loss
positions or use other internal credit enhancements to provide credit
support to the investment-grade securities.

loans. Second, some of those that do exist have limitations. As noted
earlier, we could only find five existing models that securitize small
business or CED loans and three of them use 100-percent federal credit
enhancements. CRF is the only existing securitization mechanism that
actually purchases and securitizes CED loans without direct federal
government support. However, as we also noted earlier, CRF has several
important limitations. It is the only securitizer to provide a credit
enhancement and, as a nonprofit entity, depends on the availability of
foundation and other philanthropic sources to fund its credit
enhancements. Since CRF's securities depend on private placements and do
not have credit ratings, the number of investors, particularly
institutional investors, that are able to purchase its senior tranche
securities is greatly limited too. The Section 108 model is limited by its
collateral requirements and the lengthy time needed for HUD's approval of
each loan, according to a recent Urban Institute study. The study also
found that collateral requirements may have particular force in cases
where Section 108 is used to capitalize small business lending programs
and where borrowers may have little security to offer. In addition, since
2001, with the elimination of funding for the EDI grant program, grantees
can no longer use EDI funds to satisfy, in part, collateral requirements.
Finally, the administration is proposing to eliminate Section 108. Taken
together, the limited extent of information sharing and the limitations of
securitization mechanisms inhibit the CED lending industry's willingness
and ability to efficiently sell their loans on a large scale.

  Potential Options Exist to Overcome Barriers, but Most Imply Costs or Changes
  to Federal Programs

CED lenders, their organizations, some federal agencies, and others have
identified options the federal government could employ to potentially
overcome securitization barriers. Generally, these options involve either
providing incentives or requiring or providing direct or indirect support
to resolve identified barriers. However, implementing these options singly
or in combination would have ramifications-both positive and negative-for
federal programs and the clientele served by these programs. For instance,
some options could require additional resources, while others could cause
lenders to focus less on CED lending. Some options could directly resolve
or address the barrier, while still others could improve program or lender
management. Furthermore, the options for overcoming the barriers often
entail federal costs. However, we did not determine whether the benefits
exceed the costs that could result from such efforts and, therefore, do
not endorse these options.

Potential Options for Overcoming Uncertain Borrower Demand and Limited
Lender Incentives for Securitization and Their Implications

Overcoming Uncertain Borrower Demand Might Begin with Measuring Demand

As discussed previously, uncertain borrower demand and limited lender
incentives for securitization could result in unpredictable or
insufficient loan volume necessary for securitization to work efficiently.
We have identified options that could help to better define and measure
borrower demand across markets and promote lender understanding of
borrower demand and the cost and benefits of securitization. We also
identified options for providing incentives to lenders to make loans
available for securitization. Ultimately, however, the market will largely
determine what the underlying demand for CED loans will be.

Some of the specific options for addressing uncertain borrower demand
involve requiring or supporting research into how to measure borrower
demand, helping develop and ensure application of consistent definitions
and measures for periodically measuring borrower demand across lenders and
programs, and aggregating this information. These actions could promote
increased understanding of borrower demand and may have the added benefit
of improved lender and program management-provided procedures and
definitions are clearly defined and implemented, and that measures are
taken systematically and frequently to track ever-changing markets.
However, it is unclear whether increased understanding of borrower demand,
alone, would motivate lenders to participate in securitization. In
addition, as with any data collection effort of this magnitude, it would
likely be costly and time-consuming to put a system in place. Therefore,
it may be necessary to preface any efforts with a cost-benefit analysis.

The federal government could promote lender understanding of borrower
demand through the use of forecasting tools, either across target markets
or as part of programs. Provided these tools were defined, applied, and
aggregated consistently, they could provide greater understanding of
future borrower demand across target markets. Again, given the potential
costs, a cost-benefit analysis might be warranted before pursuing such an
effort.

The federal government could require or support efforts to increase
information exchange among lenders. For instance, incentives could be
implemented for CED lenders and local banks to refer potential clients to
one another. This option could help lenders gain access to better borrower
demand information in their local markets. Another option, a peer-to-peer
system, could inform CED lenders of potential loans available outside
their traditional markets. This process could help CED lenders anticipate
changes in borrower demand across target markets, perhaps nationwide.

Federal Government Could Potentially Improve Lender Understanding of
Securitization and Create Lender Incentives for Securitization

The costs of implementing either of these options are not well known.
Without a mandate, marketing tools may be necessary to promote the use of
either of these options. Either of these options could help to make more
transparent the demand for CED loans, provided this sort of exchanged
information could be aggregated and analyzed in a useful way.

As we discussed earlier in this report, while some lenders do securitize
their loans, others lenders with securitizable loans could realize, but do
not perceive, the benefits to securitization. These lenders, for example,
may have existing low-cost sources of capital and rely on interest income
to support their operations and would have difficulty sustaining expanded
lending operations that securitization would allow. We identified options
for identifying those lenders that might benefit from securitization,
informing those lenders about securitization and its benefits, and
building incentives for lenders to securitize their loans.

The federal government could help identify lenders that could benefit from
or are ready for securitization by financing or supporting the development
of a study designed to establish criteria, procedures, and practices for
identifying such lenders, or requiring that such procedures be
implemented. However, defining and identifying lenders that could benefit
from securitization might not directly cause these lenders to consider
securitization. To do so, the federal government could also promote better
understanding of the benefits to lenders of securitization so that those
lenders that were able and would benefit from securitization would use
securitization as a means to expand community and economic development
lending. Such efforts would require costs to the federal government.

To provide greater encouragement, the federal government could also
provide direct incentives for lenders to securitize their loans. For
example, the government could build incentives for lenders (such as
program set-asides, awards, or requirements) into existing federal
programs. While built-in program incentives could have a direct impact on
lenders' willingness to securitize their loans, the impact on lenders'
missions could vary depending on how support for these incentives is
provided. For instance, unless additional funding was awarded specifically
for such incentives, providing incentives through program set-asides, or
program awards application processes, might give qualified lenders the
ability to securitize, but decrease, the amount of available funding for
all other lenders awarded grants or loans decreasing the federal support
to meet their missions.

Requiring lenders to use existing program dollars allocated to them for
securitization would not impact other lenders. However, if all lenders
with qualifying loans were required to use program dollars for
securitization, fewer dollars might go toward borrowers in the short-term
until those lenders gained access to capital from the sale of those loans.
On the other hand, the government could also eliminate disincentives to
selling loans by, for example, reducing the use of grant funds. Again,
such an option would have an immediate impact on lender behavior but also
potentially motivate lenders toward less risky lending.

Potential Options Exist to Overcome Limited Capacity, but Each Has
Implications

Limited lender capacity is an underlying reason why lenders lack
incentives to participate in securitization. To help lenders access or
analyze information on whether securitization would be useful, and to
manage increased workload they would incur if they were to securitize
their loans, some lenders need to improve their staff skills and financial
information capabilities. Additionally, lenders' long-term viability could
be enhanced through greater diversification of their portfolios.

Options the federal government could exercise include providing,
requiring, or supporting training and technical assistance to: (1)
increase skill levels of lenders in order to reduce the staff time spent
on loans, (2) improve financial and accounting information needed to make
decisions on whether benefits outweigh the costs of securitization, and
(3) inform lenders of the benefits of diversifying their portfolios.
Possible options also include supporting an increase in the number of
lender staff needed to manage any potential increases in workload they
might incur by securitizing their loans.

These options could not only move the industry closer to securitization by
improving lender knowledge and capacity needed to securitize their loans,
but could also have the added benefit of increasing lender capability and,
thus, more prudent use of federal program dollars. However, each of these
options also has other implications. For instance:

o 	Exercising options such as training and information sessions designed
to inform lenders of the benefits of diversifying their portfolios could
result in lenders investing in either larger loans or more collateralized
assets. However, altering lender portfolios in this way could result in
lenders making loans to less risky borrowers, moving them slightly
"up-market" (that is, to more creditworthy borrowers) and thus further
away from their mission. On the other hand, diversifying their portfolios
with

more of a balance of larger and smaller loans and loans of varying risks
could help lenders' long-term viability.

o 	Exercising options to increase staff skill levels through training or
providing tools to increase staff skills, improving financial and
accounting information, and for increasing the number of staff will have
added costs. Costs to the federal government will vary depending on
whether the government takes a direct or supportive role in developing and
implementing training courses or information sessions or funding increased
staff or tools for these lenders. However, improved lender management and
technical skills could increase lender efficiency.

o 	To ensure the effective use of limited federal resources, any support
for training, technical assistance, or staffing would require appropriate
federal oversight and evaluation.

Options Exist to Overcome Restrictive External Requirements, but Each Has
Implications

Our research identified a number of requirements that either directly or
indirectly limit lenders' ability to participate in securitization. To
allow lenders the ability to pool and sell loans, these requirements and
others like them, would need to be identified and either modified or
removed.

The federal government could exercise several options for identifying and
modifying or removing restrictive requirements, including requiring
programs to work collaboratively to identify and resolve conflicting
regulatory requirements that prohibit or inhibit securitization and
develop proposals for resolving conflicting statutory requirements. While
these options have the potential to expand the number of lenders that may
consider securitizing CED loans, each option has other implications such
as the following:

o 	Identification of conflicting federal, state, local, and private
requirements governing how CED funds must be spent could be costly and
time consuming because of the need to coordinate efforts on several
levels.

o 	Removing some requirements may impact lenders' ability to meet the
mission of the federal programs that support them. For example, if
requirements that lenders use loan sale proceeds to make loans with the
same purpose are eliminated, EDA has no assurance that the lenders it
supports would continue to meet program goals and objectives. Before

removing such restrictions, their purpose and rationale should be weighed
against the benefits of securitization.

Options Exist to Potentially Overcome Impact of Below-Market-rate Loans on
Securitization, but Each Has Implications

Some studies we reviewed, and lenders with whom we spoke, cite the very
nature of CED loans as a barrier to securitization because these loans
often have below-market-rates. Discounts on below-market-rate loans are a
consequence of the need to provide market yields on investments and to
cover the transaction costs associated with carrying out any
securitization. Securitization of CED loans may also require discounts to
offset any additional transaction costs due to the lack of performance
information and nonstandard loan underwriting. Loans made with limited
collateral, and with riskier borrowers, will continue to need either some
type of subsidized financing, such as the below-market-rate loans provided
by these lenders, or other mechanisms such as offering longer loan terms
that allow borrowers to make lower monthly payments.

The federal government could exercise several options to enhance lenders'
abilities to securitize below-market-rate loans. The federal government
could provide a direct subsidy or incentives for others to provide support
to lenders to offset the discount charged to lenders for securitizing
below-market-rate loans. The implementation of any one or all of the
options discussed in other parts of this section (from measuring borrower
demand to improving loan performance information) would diminish lender
costs and diminish, in part, the need for lender discounts. However, as
explained in those sections, these options have other implications as
well. Provision of a direct federal subsidy or incentives for others to
provide support would result in federal costs.

Options Exist to Overcome Lack of Standardization and Insufficient
Performance Information, but Each Has Implications

The level of heterogeneity among community lenders and loans, and the lack
of adequate performance information regarding these lenders and loans,
results in disincentives to securitize. Capital markets cannot
sufficiently, or cost-effectively assess the expected performance of a
heterogeneous pool of loans and, thus, cannot accurately assure investors
of the creditworthiness of a pool of CED loans. The benefits of
securitization are greatly reduced for community lenders as they fund any
extra transaction costs for these services and credit enhancements to
cover unexpected losses that capital markets cannot adequately profile.

Developing a Level of Standardization Would Involve Supporting Data and
Underwriting Standardization

The federal government could provide incentives (such as set-asides or
awards) for federal programs and/or capital markets (or other financial
institutions that securitize similar loans, such as commercial banks) to
collaborate in order to develop standardized performance information, loan
documentation, servicing, and underwriting criteria and procedures that
are useable for both capital markets and CED lenders. Developing new
criteria and procedures through this type of collaboration might improve
CED lenders' ability to securitize or to develop innovative financing
arrangements other than securitization. Given the varied and diverse
nature of community lenders nationwide, providing outreach and education
on any information or procedural standardization could also facilitate the
timely implementation of any new criteria or procedures.

Developing and applying homogeneous loan and lender performance
information-key performance data points, definitions underlying those data
points, frequency for reporting data, and preferred format for collecting
the data for CED lenders-has several implications. The earlier performance
information could be developed and collected from CED lenders, the sooner
CED lenders could communicate a useable performance profile to financial
institutions and thus help to improve their overall effectiveness as CED
lenders. Aggregating and maintaining performance information in a central
facility-a "data-warehouse"- accessible by CED lenders, loan pool
assemblers, and federal programs, may provide: (1) community lenders an
easier way to report and monitor their performance, thereby reducing any
administrative burdens accompanying repetitive federal reporting
requirements; (2) loan pool assemblers and rating agencies more
cost-effective means to assess and profile the risk of differing types of
CED loans, helping to diminish the securitization transaction costs
lenders currently fund; and (3) federal programs and Congress better data
to make key programmatic decisions within and across programs. Federal
support for efforts to develop and apply homogeneous loan and lender
performance information would result in costs to the federal government,
but it may improve program management in the long-term. Deciding where to
develop, store, and manage this data should take in account, privacy,
access, and Freedom of Information Act issues.

Developing homogeneous loan underwriting, servicing, and documentation
standards would likely require a balance between the level of
standardization necessary for cost-effective, reliable performance
estimates and a sufficient level of flexibility for CED lenders to meet
the needs of their communities. The tighter the standards, the less likely
CED

lenders would be able to tailor their services to their communities, thus
potentially diminishing the effectiveness and benefits of CED lenders to
communities. Conversely, the looser the standards, the more costly
assessing the performance of CED loans becomes, thus diminishing the
benefits of securitization as a funding source for CED lenders. Developing
a range of underwriting and servicing standards for a variety of loan
products would limit lender flexibility for a particular loan product, but
these standards may be designed to accommodate the mission of community
lenders. Additionally, with enough available loan and lender information,
a range of standards may allow a pool assembler to assemble a reasonably
homogeneous pool of similar loans from a nationwide pool of
mission-oriented CED lender portfolios. Developing standards for
underwriting, servicing, and documentation can require substantial effort.
To the extent that these efforts are funded through federal programs, or
through incentives provided lenders and others, these efforts may impose
federal costs.

Credit Scoring Could Diminish The federal government and CED lenders could
examine the use of credit

Need for Other Information	scoring as an indicator, for example, of the
likelihood of borrower repayment of principal and interest. Some
commercial banks now consider credit scores primary criteria for
underwriting small business credit decisions. Several studies and
interviews have indicated that credit scoring is a technique with the
potential to reduce the need for standardized underwriting procedures.
Using credit scores to estimate the likely performance of a pool of loans
based upon borrowers with similar creditworthiness might be more
cost-effective than estimating the performance of a pool of heterogeneous
loans. If credit scores produce performance probability estimates reliable
enough for rating agencies, investors and lenders can more accurately
assess their financial incentives and disincentives to securitize CED
loans. Additionally, credit scores may reduce the cost of loan
origination. Whether credit scoring loans will affect the missions of CED
lenders is somewhat dependent on the lender. Credit scoring may allow CED
lenders to underwrite loans tailored to their target markets and sell
occasional loans to pools accepting certain credit score ranges. Or, some
CED lenders might only originate loans with credit scores acceptable for
resale into pools accepting certain credit score ranges, thereby limiting
the types of lending they would do in their communities. Credit scoring
might limit borrowers with little or no credit history from accessing CED
financings. Finally, questions still exist as to whether credit scoring
disadvantages minority or other segments of the population.

Use of Governmental Credit Enhancements Could Minimize the Need for Other
Loan Performance Data

Governmental credit enhancements could be applied in a number of ways, but
could result in increased costs to the federal government. However, the
level of the credit enhancement would determine the extent to which
standardization and performance data would be needed. A security issued
with a 100-percent federal credit enhancement could minimize the need for
standardization and loan performance data because it is backed by the full
faith and credit of the federal government and, therefore, would not need
to obtain an independent credit rating. However, such a federal credit
enhancement could expose the federal government to potentially greater
risk and cost and would also require a minimum degree of standardization
and review, depending upon the capabilities and loan performance record of
the lender. For example, in FHA's Multifamily Insurance Risk-Sharing
Program, state and local housing finance agencies receive a 100-percent
federal credit enhancement, and the most experienced lenders are allowed
to use their own underwriting standards and documents in return for
assuming 50-90 percent of the credit risk. Compared with a 100 percent
credit enhancement, a partial federal credit enhancement reduces the
government's risks and potential costs, but generally subjects the loans
to be securitized to an evaluation by the credit rating agencies or
investors (for unrated securities). Such an evaluation would necessarily
include the standardization and loan performance issues discussed earlier.
Whether a 100 percent or a partial federal credit enhancement, federal
agencies will need sufficient loan performance data to estimate the credit
subsidy cost of the credit enhancement. Given the possible increased cost
and risk the government incurs, credit enhancements should be minimized
and their continuing need be assessed periodically. Such assessments would
require criteria for determining the continued need for credit
enhancement.

Options Exist to Potentially Overcome Limited Mechanisms for Securitizing,
but Each Has Cost and Other Implications

Lack of or limits in information sharing and securitization mechanisms are
seen by many as a barrier to securitization. Currently, there is no
comprehensive mechanism for lenders, investors, and capital market
intermediaries to share information on loan volume with interested loan
buyers and sellers. There are also few mechanisms available to securitize
small business and CED loans, and there are limitations with some of the
existing mechanisms. We have identified several options for creating a
consistent mechanism for securitizing CED loans. These options are as
follows:

o 	The federal government could help establish formal networks for lenders
and capital market participants to exchange information on loans available
for sale and for interested loan purchasers to provide

specialized origination and loan sale functions. Examples of networks
could include a formalized group of lenders, investors, and capital market
intermediaries or super-regional CED lenders who would be part of a
voluntary regional network of local CED lenders. For the networks to be
effective, they would need to provide tangible benefits to both lenders
and capital market participants. For example, super-regional lenders could
specialize in originating and selling larger, long-term loans referred to
them by retail lenders, who could participate in the underwriting and loan
servicing responsibilities and share in the loan fees. This may also allow
local lenders more time to concentrate on smaller, short-term loans to be
held in their portfolios. Implementing the networks may also require
different degrees of federal funding.

o 	Two existing securitization mechanisms that could serve as a basis for
greater securitization of CED loans are CRF and the Section 108 guaranteed
security programs. However, these structures have certain limitations that
would first need to be addressed. CRF depends on the availability of
foundation and other philanthropic sources to fund its credit
enhancements, thereby limiting its capacity to sell more securitized loans
to investors. Since CRF's securities have only been privately placed and
do not have credit ratings, the number of investors, particularly
institutional investors, who are able to purchase its senior tranche
securities is limited. Increasing CRF's capacity to securitize more loans
and providing it with a large enough credit enhancement would allow CRF to
obtain a credit rating. Addressing CRF limitations could include providing
direct federal funding for partial credit enhancements or match funding to
attract other funding sources such as state and local government and
program-related investors, as well as assistance in developing
standardized loan products. However, providing partial federal credit
enhancements could have both positive and negative effects depending upon
the credit risks associated with the lenders and loans included in each
loan pool to be securitized. Such credit enhancements would likely impose
costs on the federal government. In addition, these options may have a
negative impact on lender mission if standardization reduces lender
flexibility to the point that loan terms no longer meet borrower needs or
excludes targeted borrowers. However, lenders may be able to target
greater resources to serving targeted markets if they can offer new loan
products such as, long-term, fixed-rate real estate loans. In addition,
the Urban Institute study found that the average loan size of Section 108
loans to third

parties was about $1.5 million.44 Thus, the model securitizes much larger
loans than many of those financed by many lenders covered in our review.
For example, the average loan size for CDFIs is $66,000 for business loans
and $11,600 for microenterprise loans. Finally, as indicated previously,
the administration is proposing elimination of the Section 108 program. If
the program remains or the model is adopted elsewhere, the model's current
limitations could be addressed. For example, the government could address
the collateral concerns, particularly by communities that capitalize loan
funds, while taking into account risks borne by the federal government.
The government could also assess why the Section 108 model is not used
more widely to securitize CED loan funds. This would require a better
understanding of the extent to which Section 108 loan guarantees are used
as a funding source for loan funds. Such efforts would involve costs for
the federal government, but could lead to improvements in the program's
and the securitization mechanism's usage.45

o 	The government could also opt to create new securitization mechanisms
ranging from those with little or no credit enhancements to options with
full credit enhancements. These structures could be supported by different
entities such as the federal government or the private sector. For
example, the government could create a new mechanism similar to the CDA
securitization model with a partial federal credit enhancement. Another
option might be a demonstration program with a 100-percent federal credit
enhancement of the security plus sharing the credit risk of the underlying
loans in a manner similar to the FHA Multifamily Risk-Sharing Program
described earlier. For instance, if the risk-sharing demonstration with a
100-percent federal enhancement of the security were limited to CED
lenders with high performing portfolios and high loan volume,
standardization requirements would be minimized, thereby reducing lender
mission impact. But this sort of federal credit enhancement might have
negative cost consequences for the federal government, depending on the
effectiveness of the risk-sharing mechanisms adopted and the quality of
the lenders and loans included in the program. The implications for the
proposed CDA model are less

44Some of the loans securitized under the Section 108 program are used to
fund smaller loans to individual businesses through RLFs and nonprofit
intermediaries such as CDCs.

45In providing technical comments, HUD suggested that fees could be but
are currently prohibited from being charged to create a loan loss reserve
for securitizing these loans. However, we did not assess the implications
of this option.

known since there are no current securitization models that use partial
federal credit enhancements to securitize any loans. Since CDA proposes to
purchase only seasoned loans and update their borrowers' credit scores,
the need for standardization may be minimized because credit rating
agencies would know the loans' short-term financial performance and their
borrowers' current creditworthiness. Since the rating agencies would still
not have the long-term loan performance data they need to statistically
predict loan delinquencies and defaults, they would adjust the amount of
credit enhancement upward, but by a smaller amount than required for pools
of new loans with outdated credit scores. Overall, any options for
providing enhancements to create additional mechanisms for securitization
will require administrative effort and federal costs.

o 	The government could also build upon existing structures that
securitize non-CED loans by providing incentives for private sector
entities to securitize CED loans. However, private sector securitization
entities may not agree to securitize CED loans or may "demand" too high a
cost to the federal government. In addition, because private
securitization mechanisms require standardized underwriting, lenders'
mission may be negatively impacted. However, the impact standardization
might have on lender mission could be mitigated if securitization could
provide CED lenders with new kinds of loan products that they generally do
not now originate, that is, larger, long-term, fixed-rate loans. Overall,
providing incentives to private sector entities to securitize CED loans
would require federal costs. To ensure the effective use of federal
resources, any such program or incentives would also require appropriate
federal oversight and evaluation.

Observations	Given the importance of volume in achieving efficiencies that
could help securitization work effectively, uncertain borrower demand and
limited lender incentives are critical barriers that would need to be
addressed if CED loans are to be securitized widely. Therefore,
securitization may not be a significant alternative for these lenders
until the volume of loans available for securitization is known
industrywide, and lenders are convinced of its benefits enough to
participate. Further, limited lender management capacity, prohibitive
external legal or regulatory limitations and requirements, and discounts
due to below-market-rate financing are barriers consequent to the nature
of CED lending. For varying reasons discussed in detail above, these
barriers also combine to explain the lack of lender incentives to
securitize their loans. Therefore, these barriers, along

with the cost associated with their elimination, are factors to be
addressed if CED loans are to be securitized widely. In addition,
eliminating these barriers entail costs.

The remaining barriers-lender heterogeneity, insufficient performance
information, and limited mechanisms for securitizing loans-are traditional
barriers that have been experienced to some degree in the development of
other securitization models. Some of the actions we outline, such as
developing homogeneous documentation and performance information, may help
to improve lenders' overall effectiveness in dealing with local and
national capital markets in a range of financing transactions, including
securitization, and could help improve program management. However, the
costs and benefits of these actions should be assessed before they could
be considered viable. Developing homogeneous underwriting and servicing
policies requires recognition of the tension between the flexible
underwriting these lenders employ to serve their communities versus the
standardization needed to cost-effectively securitize loans. Additionally,
any mechanisms developed to further CED loan securitizations will not
succeed without visible financial benefits for lenders and capital market
participants.

In addition, some of the options we have identified to improve lender
management practices, data on lenders and loans, and consistency in
assessing and documenting loans could not only move the industry closer
toward securitization, but could have the added benefit of improved
management and oversight for lenders and the federal programs that support
them. However, their costs and benefits need to be assessed. If
cost/benefit analyses prove them to be cost-effective, these are steps
that could help the industry regardless of whether securitization becomes
a viable option.

While the options we identify have many likely implications, we did not
measure the extent to which each may affect lenders' mission, federal
costs, program oversight, and other potential implications. Likewise, we
did not determine whether the potential benefits exceed the costs that
could result from such efforts. We, therefore, do not endorse these
options. Nonetheless, the information we present provides a framework for
understanding the challenges when considering the federal role in
facilitating securitization.

Agency Comments and 	Officials in all agencies provided technical comments
that we incorporated into the report, where appropriate. The technical
comments from HHS

Our Evaluation	were from officials in HHS's Administration for Children
and Families. Generally, the agencies did not indicate whether they agreed
or disagreed with the report's findings.

We are sending copies of this report to interested congressional parties
and
to the Secretaries of Agriculture, Commerce, Health and Human Services,
Housing and Urban Development, and Treasury, the SBA Administrator,
and the Federal Co-Chair of the Appalachian Regional Commission. Copies
will be made available to others upon request. In addition, the report
will
be available at no charge on the GAO Web site at http://www.gao.gov.

Please contact Mathew J. Scire, Assistant Director, or me at (202)
512-8678,
or by e-mail ([email protected] or [email protected] ) if you or your staff
have any questions concerning the report. Key contributors to this report
were Diane T. Brooks, Tiffani L. Green, Mitchell B. Rachlis, Barbara M.
Roesmann, Keith A. Slade, and James D. Vitarello.

William B. Shear
Director, Financial Markets

and Community Investment

List of Congressional Requesters

The Honorable Hillary Rodham Clinton United States Senate

The Honorable Susan Collins United States Senate

The Honorable Christopher J. Dodd United States Senate

The Honorable Tom Harkin United States Senate

The Honorable James M. Jeffords United States Senate

The Honorable Edward M. Kennedy United States Senate

The Honorable John F. Kerry United States Senate

The Honorable Patrick J. Leahy United States Senate

The Honorable Carl Levin United States Senate

The Honorable Jack Reed United States Senate

The Honorable Paul E. Kanjorski House of Representatives

The Honorable James A. Leach House of Representatives

The Honorable John M. McHugh House of Representatives

The Honorable Jack Quinn House of Representatives

Appendix I

                       Objectives, Scope, and Methodology

Our objectives were to: (1) describe the characteristics of selected
federally sponsored Community and Economic Development CED lenders; (2)
describe the characteristics of selected federal programs that support CED
lenders; (3) describe selected efforts to securitize economic development
loans; (4) determine the barriers to securitizing economic development
loans; and (5) identify options for overcoming these barriers, as well as
the implications of the identified options. We limited the scope of our
work to securitization and did not include alternative means for lenders
to access private capital.

  CED Lender Characteristics and the Performance of Their Loans

Our review focused on the seven types of federally sponsored CED lenders
that we were specifically requested to include and identified as key CED
lenders.1 They are the following:

o  Community Development Financial Institutions (CDFIs),

o  Revolving Loan Funds (RLFs),

o  Intermediary Relenders (IRPs),

o  Community Development Corporations (CDCs),

o 	Small Business Administration's (SBA) 504 Certified Development
Companies (504 CDCs),

o 	lenders supported by entitlement city and state grantees under the U.S.
Department of Housing and Urban Development's (HUD) Community Development
Block Grant Program and lenders supported by the Section 108 Loan
Guarantee program, and

o  microlenders.

To describe the characteristics of selected federally sponsored CED
lenders, we reviewed and synthesized studies, reports, data, and
information from industry nonprofits, trade associations, and federal

1Although we identified one other lender group--Community Development
Entities under Treasury's New Markets Tax Credit-we did not review these
lenders because Treasury just recently (2002) established Community
Development Entities, and limited information was available on them.

                                   Appendix I
                       Objectives, Scope, and Methodology

program data on selected CED lenders and lending programs. We also
interviewed CED lenders, their trade associations, and other industry
groups. We then used the information collected from the identified sources
to document and describe, where available, the following:

o  purpose of (mission) and target markets served by the lender group;

o  lender's sources of capital;

o 	characteristics of the lender group (for example, number of loans,
amount of loans);

o  reported impacts on target markets served; and

o  attempts to measure and define demand for liquidity and capital.

Finally, we documented the availability of data describing the
characteristics and performance of the loans that CED lenders make. Loan
performance data were inconsistently available for all lender groups;
therefore, we were unable to assess the performance of CED loans in
general. However, we were able to document differences in how loan
performance was measured. We also identified three current efforts to
collect loan-level data on CED loans made by select CED lenders in EDA,
HUD, and Treasury's CDFI Fund. We attempted to obtain summary data from
these sources on the dollar amount and number of loans in default in order
to estimate a cumulative default rate for each program. However,
Treasury's CDFI Fund data were inconsistent and incomplete for our
analysis. Comparable data on HUD loans were not available at the time of
this report. We did not independently verify the data, but we corroborated
it against various sources.

  Selected Federal CED Programs

Our review focused on 11 federal programs that support the seven types of
CED lenders targeted. 2 Programs selected for review, the lenders they
fund, and the agencies that administer them are listed in table 9.

2While there are other federal programs that support economic development
activity, we focused on those within the seven federal agencies we were
requested to review that support seven types of CED lenders targeted. For
example, HHS administers the Community and Economic Development
Discretionary Grant program. However, the program could only recently be
used to fund RLFs. Also, see previous footnote.

                                   Appendix I
                       Objectives, Scope, and Methodology

Table 9: Federal CED Lending Programs, Lender Types, and Sponsoring
Agencies Included in Our Review

            Federal program          Lender type      Sponsoring agency       
    Intermediary Relending program      IRPs               U.S. Department of 
                 (IRP)                                            Agriculture 
                                                            (USDA)            
    Rural Business Enterprise Grant     RLFs                 USDA             
            program (RBEG)                       
    Economic Adjustment Assistance      RLFs                                  
                Program                           U.S. Department of Commerce
                                                     Economic Development     
                                                     Administration (EDA)     
    Business Development Revolving      RLFs             Appalachian Regional 
           Loan Fund program                                       Commission 
                                                            (ARC)             

Community Development Block Grant (CDBG) (entitlement Local lenders U.S.
Department of Housing and cities and state-administered) Urban Development
(HUD)

Section 108 loan guarantee     Local lenders                HUD            
    Community Services Block      Local lenders     U.S. Department of Health 
          Grant (CSBG)                                         and            
                                                      Human Services (HHS)    
      Financial Assistance                             U.S. Department of     
     component of CDFI Fund           CDFIs                 Treasury          
                                                      (Treasury) CDFI Fund    
504 Certified Development  Certified Development            Small Business 
       Company (504 CDC)                  Companies      Administration (SBA) 
                                     (CDCs)         
       Microloan Program          Microlenders                 SBA            
          Source: GAO.                              

Enterprise Community/Empowerment Zone Grant (EZ/EC) RLFs USDA, HHS, and
HUD

For each program we analyzed the following:

o  purpose and target markets served by the program,

o  how the federal government supports the CED lending program,

o  restrictions on the use of the federal funds,

o 	types of performance and lender activity information that the program
collects,

o  volume of program activity, and

o  budgetary costs of funding the program's CED lending activity.

                                   Appendix I
                       Objectives, Scope, and Methodology

                            Selected Securitization
                             Efforts for CED Loans

Our review focused on eight models-five existing and three proposed- that
are intended to serve small business and CED lenders. SBA's 7(a)
guaranteed and unguaranteed models and the two HUD Section 108 models were
specifically requested. The remaining four models were identified through
our contacts with agency officials and other parties.

The five existing models are:

1. SBA's 7(a) guaranteed model,

2. SBA's 7(a) unguaranteed model,

3. SBA's 504 model,

4. HUD's Section 108 model,

5. The Community Reinvestment Fund's (CRF) model The three proposed models
are:

1.	HUD's proposed CDBG/Section 108 unguaranteed model for securitizing CED
loans,

2.	Commonwealth Development Associates' (CDA) proposed model for
securitizing CED loans,

3.	Capital Access Group's proposed securitization model, building on
existing state-level Capital Access lending programs

For each of the models, we then collected and summarized information about
the following:

o  models' structure, including lenders and borrowers served;

o  securitized volume of each model;

o  loan types included in the models' loan pools;

o  financial benefits and risks to the participants in the models; and

o  barriers to securitization the models faced.

                                   Appendix I
                       Objectives, Scope, and Methodology

  Barriers to CED Loan Securitization

To identify barriers to securitization, their causes and proposed
solutions, we (1) reviewed and synthesized studies and reports obtained
from literature searches completed on securitization of economic
development loans and selected sources we thought were most relevant to
our review; (2) relied on relevant documents and studies identified in
interviews with program officials, lenders, and their trade associations
referred to previously; and (3) pinpointed barriers faced in the eight
securitization models reviewed and the extent to which the barriers have
been overcome. We limited our review to those documents that identified
barriers to CED loan securitization and did not include those that
discussed barriers to accessing capital through other means. We
synthesized information on barriers in these documents into a single
matrix uncovering over 264 citations of barriers to securitization, their
causes, and any proposed solutions. We then developed logical groupings
that characterized the barriers and assessed the reliability of these
groupings by having teams of two independently code them and reach
consensus on areas where original coding did not agree. The six categories
that appear in this report are as follows:

o  uncertain borrower demand and limited lender interest,

o  insufficient lender capacity,

o  external requirements attached to capital sources,

o 	below-market-rate loan products will not meet market requirements
without a discount or subsidy,

o  lack of standardization and inadequate performance information, and

o  limited mechanisms available to support securitization for CED loans.

Options for We relied upon the proposed solutions identified in the
barrier analysis

described above and our professional judgment to identify strategies
forSecuritization and overcoming barriers to securitizing economic
development loans. We Their Implications considered a range of options
available to the federal government to

address the barriers developed in our analysis. Federal options generally

include the following:

o  potential modification(s) of legal or program requirements,

Appendix I
Objectives, Scope, and Methodology

o 	potential incentives within existing programs to promote participant
interest and/or the ability to securitize, and

o  potential actions to help improve lender capacity.

We do not endorse the options we identified and, given the scope of this
report, note that these options are designed to address barriers to
securitization, rather than improving access to capital through other
means.

We also used our professional judgment and that of experts in the field to
determine the potential implications of each option. We developed a range
of implications based upon our research and discussions with program and
industry experts. The potential implications of the options generally
considered whether the option could result in

o  conflicts with lenders' mission,

o  need for new federal funding or resources,

o  direct and/or immediate impact on the barrier being targeted, and/or

o  improved lender or program management.

While we recognize that options could entail additional federal costs, we
do not determine whether the benefits exceed the costs that could result
from such efforts.

Our work was conducted in Manchester, New Hampshire; Philadelphia,
Pennsylvania; and Washington, D.C., between October 2002 and July 2003 in
accordance with generally accepted government auditing standards. We
obtained comments on a draft of this report from U.S. Department of
Agriculture; U.S. Department of Commerce; U.S. Department of Housing and
Urban Development; U.S. Department of Treasury; U.S. Small Business
Administration; U.S. Department of Health and Human Services; and the
Appalachian Regional Commission which we incorporated into the report,
where appropriate.

Appendix II

Model Descriptions

Model Lenders Borrowers Model structures

SBA 504 program Certified Creditworthy, for-In existence since 1986, the
SBA 504 program provides creditworthy small

Development Companies profit small businesses who have qualified for
conventional loans businesses with fixed-rate, long-term subordinate
loans, primarily for commercial real estate (not to exceed 40 percent of
the total loan amount). A third-party lender must provide at least 50
percent of the project amount. Each 504 CDC loan is funded by a guaranteed
debenture and sold by SBA's designated trust agent, who pools them and
issues U.S. Government Guaranteed Development Company Participation
Certificates. These certificates are sold to investors through
underwriters with timely payment of principal and interest guaranteed by
SBA. Community Nonprofit, for-Local business, CRF is a nonprofit secondary
market maker for CED-based lenders Reinvestment Fund profit, and
affordable nationwide. It purchases and warehouses loans from community
lenders (CRF) governmental housing, and and uses the loans to back
securities issued to private investors through

                                                SBA has been authorized to    
    SBA 7(a)     Commercial    For-profit small securitize 7(a) guaranteed    
                                                loans since 1984.             
                                                   The program provides a     
guaranteed  banks, credit   businesses that   guarantee on a portion of a  
                                                     small business loan      
                                                ranging from 50 percent to 85 
               unions, small   could not obtain      percent, following SBA's 
                                                          review and approval 
                                                          of each loan unless 
              business lending    financing         originated by a preferred 
                                                 lender. The lender may elect 
                                                                           to 
                                                 sell the guaranteed portion  
               companies and      elsewhere          of each loan to an       
                                                   SBA-approved loan pool     
                                                assembler, which issues       
               other nonbank                    SBA-guaranteed securities to  
                                                investors. Working            
                                                capital, equipment, and real  
                  lenders                       estate loans may be included  
                                                        in these loan         
                                                pools, which normally carry a 
                                                   variable interest rate.    

                                                     SBA first authorized the 
     SBA 7(a)      Commercial    For-profit small        sale of unguaranteed 
                                                    portions of 7(a) loans on 
                                                                          the 
                                                    secondary market in 1992. 
unguaranteed  banks, credit   businesses that    On February 10, 1999, SBA 
                                                          issued a Final Rule 
                                                      that created a new      
                 unions, small   could not obtain  regulatory regime for all  
                                                   participating lenders in   
                                                             this             
                                                  program. Lenders pool their 
                business lending    financing     loans and issue securities  
                                                       to investors that      
                                                      include internal credit 
                 companies and      elsewhere        enhancements provided by 
                                                    the lender. To date, each 
                                                  security has been rated as  
                 other nonbank                    investment-grade by credit  
                                                       rating agencies.       
                    lenders                       

                                               Operating since 1978, the      
HUD Section 108 CDBG grantees For-profit or Section 108 permanent          
                                               financing program              
                                               provides both the actual       
     guaranteed      and their     nonprofit   financing for the securities   
                                               and a 100 percent              
                                                  federal credit enhancement. 
                    designated     borrower         Payments on the loans are 
                                                            passed through to 
                                                the Section 108 note holders. 
                      lenders                  The principal security for the 
                                                               loan guarantee 
                                               is a pledge by the applicant   
                                               community or the state (for    
                                               nonentitlement                 
                                                  communities) of its current 
                                                       and future CDBG funds. 
                                                     Additional security will 
                                                     also be required by CDBG 
                                                 grantees to assure repayment 
                                                            of the guaranteed 
                                                        obligations.          

community community private placements. These securities include a variety
of credit development facility borrowers enhancements, including
subordinated tranches that are typically financed lenders. with loans and
grants from private foundations.

                                                          CDA was part of the 
       Proposed     Nonprofit, for- Small business       Economic Development 
                                                             Administration's 
                                                               securitization 
                                                       pilot in 1999. CDA     
     Commonwealth     profit, and    borrowers not  proposed to pool economic 
                                                      development loans and   
                                                    acquire a rating using a  
     Development     governmental   served by local credit-scoring model.     
                                                    Under the CDA model, loan 
                                                     originators were to hold 
Associates (CDA)    community      commercial       the loans until enough 
                                                       loans became available 
                                                                        for a 
                                                      rating and sale as a    
                      development      financial     private placement, with  
                                                     partial internal credit  
                                                     enhancements funded by   
                       lenders.      institutions      each participating     
                                                       lender, as well as     
                                                            external          
                                                     enhancements funded with 
                                                    public or private monies. 
                                                         Since CDA was unable 
                                                    to achieve the minimum    
                                                    loan volume required by   
                                                    the credit rating agency, 
                                                       the model was never    
                                                          implemented.        

Appendix II
Model Descriptions

(Continued From Previous Page)

Model Lenders Borrowers Model structures

                                            Under contract with HUD, the      
     Proposed   CDBG-grantees For-profit or Urban Institute has proposed a    
                                            structured                        
                                            finance securitization model that 
    CDBG / 108    and their     nonprofit   includes a small senior tranche,  
                                            a large                           
                                            subordinated tranche, and a       
unguaranteed  designated     borrower    residual retained by the loan     
                                            seller equal to                   
                                               about 20 percent. This assumes 
                   lenders                        that a bank has provided 35 
                                                               percent of the 
                                                   project cost with a senior 
                                                     collateral position. The 
                                                     remaining 55 percent has 
                                               been provided by the community 
                                              with either Section 108 or CDBG 
                                                                   funds in a 
                                            junior collateral position. The   
                                            senior tranche would be sold to   
                                            investors as                      
                                            an investment-grade security. An  
                                            alternative is to include the     
                                            senior bank                       
                                               loan portion in the loan pool, 
                                             thereby also increasing the size 
                                                                of the senior 
                                                        tranche.              

                                                         Proposes to purchase 
      Proposed     CDFI lenders     Minority      subordinated loans to small 
                                                     businesses and nonprofit 
                                                  organizations (25-40        
Capital Access                  businesses,    percent of total loan       
                                                  amount), that would require 
                                                  100                         
       Program                                    percent financing, assuming 
      variation                  nonprofits, and  a commercial bank agrees to 
                                                          provide the         
                                                  remaining 60-75 percent as  
                                commercial real       a senior collateral     
                                                      position. Only the      
                                                   subordinate loan would be  
                                estate properties  sold as securities, with   
                                                    primarily the borrower    
                                                  and possibly the lender,    
                                                  the state, or the federal   
                                                  government providing the    
                                                       necessary credit       
                                                  enhancements to investors.  

               Sources: SBA, HUD, CRF, CDA, Capital Access Croup.

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